int. flow of fund

8/12/2019 Int. Flow of Fund

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International Flow of Funds


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Chapter Objectives

Explain the key components of the balance ofpayments,

Explain the growth in international trade activity overtime,

Explain how international trade flows are influencedby economic factorsand other factors,

Explain how international capital flows are influencedby country characteristics,

Introduce the agenciesthat facilitate the internationalflow of funds.


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Balance of Payments

Definition:Summary of transactions between domestic and

foreign residents for a specific country over a specified

period of time.

It represents an accounting of a countrysinternational

transactions for a period of one year or a quarter.

It accounts for transactions by businesses, individuals,

and the government.


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Each transaction is recorded as both a credit and a debit,

i.e. double-entry bookkeeping.

Sources of funds for a nation, such as exports or the

receipts of loans and investments, are recorded as credit.

Uses of funds, such as for imports or to invest in foreigncountries, are recorded as debit.

Alternatively, sources and uses of funds method of

accounting can be used whereby:sources = credits = pluses

uses = debits = minuses

Balance of Payments


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Components of Balance of Payment

The balance of payments statement can be

broken down and are presented in three groups:

A current account

A capital account

A financial account


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The current account summarizes the flow of fundsbetween one specified country and all other countries due

to purchases of goods or services, or the provision of

income on financial assets.

A current account deficit suggests a greater outflow offunds from the specified country for its current

transactions

Key components of the current account include:

i. Balance of trade(exports and imports of merchandiseand service)

ii. Factor income(interest & dividends)

iii.Transfer payments(aids, gifts, & grants).

Current Account


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Current Account


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Capital Account

The capital account summarizes the flow of funds

resulting from the sale of assets between one

specified country and all other countries.

It also includes the value of non-produced nonfinancial

assets that are transferred across country borders, such

as patents and trademarks.


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Capital Account

The key components of the capital account are:

direct foreign investment:investment in fixed

assets in foreign countries (firm expansion)

portfolio investment:transactions of long-termfinancial assets

other capital investment:transactions of short-

term financial assets


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Financial account

The financial account records an economys transaction in

external financial assets and liabilities.Financial Account* = Change in the ownership of domesticassets-change in the ownership of foreign assets.

Financial Account* = Foreign Direct Investment

+ Foreign Portfolio Investment

+Other Investments

+Reserve Account

A surplus in the capital account and Financial Account meansmoney is flowing into the country, but unlike a surplus inthe current account, the inbound flows will effectively beborrowings or sales or transfer of assets rather than earnings.

* Capital Account


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Balance Of Payment

If a country has a negative current account balance, itshould have a positive capital and financial account

balance.

In fact, the negative balance on the current account should

be offset by a positive balance on the capital, may be inthe form of borrowing or foreign investment. However,

there is not normally a perfect offsetting effect because

measurement errors can occur when attempting to

measure the value of funds transferred into or out of a

country. For this reason, the balance-of-payments account

includes a category of errors and omissions.


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BOP of Pakistan

Items Jul-Sep Oct-Dec Jan-Mar Apr-Jun

Current Account balance -1,367 -1,032 -639 -1,620 -4,658 214

Trade balance (Goods) -4,241 -3,776 -3,820 -3,928 -15,765 -10,516

Exports 6,149 5,923 6,262 6,362 24,696 25,356

Imports 10,390 9,699 10,082 10,290 40,461 35,872

Services (net) -746 -619 -732 -1,095 -3,192 -1,940

Income (net) -650 -922 -690 -983 -3,245 -3,017

Current transfers (net) 4,270 4,285 4,603 4,386 17,544 15,687

Capital Account (net) 31 59 54 39 183 161

Financial Account(net) 602 -326 145 859 1,280 2,101

Errors and Omissions (net) -25 266 -419 98 -80 16

Overall balance -759 -1,033 -859 -624 -3,275 2,492

Rese rve and Related Item 759 1,033 859 624 3,275 -2,492

Table 1: Balance of Payments - Summary (Million US dollar)

FY12

FY12 FY11


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Trading Partners of Pakistan


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Foreign Trade (Pakistan)


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Factors Affecting International Trade Flows Inflation

A relative increase in a countrys inflation rate willdecrease its current account, as imports increaseand exports decrease.

National Income A relative increase in a countrys income level will

decrease its current account, as imports increase. Government Restrictions

A government may reduce its countrys imports byimposing tariffs on imported goods, or by

enforcing a quota. Note that other countries mayretaliate by imposing their own trade restrictions.

Sometimes though, trade restrictions may beimposed on certain products for health and safetyreasons.


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Factors Affecting International Trade Flows

Some governments offer subsidies to theirdomestic firms, so that those firms can produceproducts at a lower cost than their globalcompetitors.

Exchange Rates If a countrys currency begins to rise in value, its

current account balance will decrease as importsincrease and exports decrease.

Note that the factors are interactive, such that theirsimultaneous influence on the balance of trade is acomplex one.


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Impact of Exchange Rates

During the 19971998 Asian crisis, the exchange rates

of Asian currencies declined substantially against the

dollar, which caused the prices of Asian products to

decline from the perspective of the United States andmany other countries. Consequently, the demand for

Asian products increased and sometimes replaced the

demand for products of other countries.


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Interaction of Factors

The factors that affect the balance of trade interact,

their simultaneous influence on the balance of trade

is complex.

For example, as a high Pakistan inflation rate reducesthe current account, it places downward pressure on

the value of Rupees. Since a weaker Rupee can

improve the current account, it may partially offset

the impact of inflation on the current account.


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International Capital Flows

1. Foreign Direct Investment

2. Foreign Portfolio Investment

One of the most important types of capital flows is

direct foreign investment.

Firms commonly attempt to engage in direct foreign

investment so that they can reach additionalconsumers or can rely on low-cost labor and other

resources.


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Factors Affecting DFI

Changes in Restrictions - During the 1990s, many

countries lowered their restrictions on DFI, thereby

opening the way to more DFI in those countries.

Privatization - Several national governments haverecently engaged in privatization, or the selling of

some of their operations to corporations and other

investors.


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Tax Rates on Interest or Dividends - Investors

normally prefer to invest in a country where the

taxes on interest or dividend income from

investments are relatively low.

Interest Rates - Portfolio investment can also be

affected by interest rates. Money tends to flow to

countries with high interest rates, as long as the local

currencies are not expected to weaken.

Factors Affecting International PortfolioInvestment


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Exchange Rates-If a countrys home currency is

expected to strengthen, foreign investors may be

willing to invest in the countryssecurities to benefit

from the currency movement.

Conversely, if a countrys home currency is expected

to weaken, foreign investors may decide to purchase

securities in other countries.

Factors Affecting International PortfolioInvestment


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Impact of International Capital Flows

Foreign investors are especially attracted to a

countrys financial markets when the interest rate in

their home country is substantially lower than that in

the foreign country.

Japans annual interest rate is closer to 1% while

Pakistans interest rate is closer to 12 % because of

low saving rate. So Pakistan is attractive country as

compared to Japan, if other things remain constant.


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Should Pakistan Rely to Much on ForeignFunds

Pakistan is relying on foreign funds and access to the

foreign funds has allowed more growth in Pakistan.

Pakistan should be able to rely on substantial foreign

funding in the future as long as Pakistani governmentand firms are still perceived to be creditworthy. If

that trust is ever weakened, Pakistan government

and firms would only be able to obtain foreign

funding if they paid a higher interest rate tocompensate for the risk (a risk premium).


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Agencies That Facilitate International Flows

1. International Monetary Fund Established as a result of United Nations Monetary

& Financial Conference in 1944 to promote:

a) Cooperation among countries on internationalmonetary issues

b) Stability in exchange rates

c) Provide temporary funds to member countries

attempting to correct imbalances of internationalpayments

d) Promote free mobility of capital funds across

countries and free trade


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2. World Bank

The International Bank for Reconstruction andDevelopment (IBRD), also referred to as the World

Bank, was established in 1944.

Its primary objective is to make loans to countries to

enhance economic development.

It has a profit-oriented philosophy. Therefore, its loans

are not subsidized but are extended at market rates to

governments


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World Trade Organization

This organization was established in 1993 to provide

a forum for multilateral trade negotiations and to

settle trade disputes related to the GATT accord.

Member countries are given voting rights that are

used to make judgments about trade disputes and

other issues.


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International Financial Corporation

International Financial Corporation (IFC) was

established in 1965 to promote private enterprise

within countries.

IFC works to promote economic developmentthrough the private rather than the government

sector.

It not only provides loans to corporations but also

purchases stock, thereby becoming part owner in

some cases rather than just a creditor.


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Bank for International Settlements

BIS attempts to facilitate cooperation among

countries with regard to international transactions.

The BIS is sometimes referred to as the central

bankscentral bankor the lenderof last resort. It played an important role in supporting some of the

less developed countries during the international

debt crisis in the early and mid-1980s.


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Organization for Economic Cooperationand Development

The Organization for Economic Cooperation and

Development (OECD) facilitates governance in

governments and corporations of countries with

market economics. The OECD promotes international country

relationships that lead to globalization.


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Regional Development Agencies

Inter-American Development Bank

Asian Development Bank

African Development Bank

European Bank for Reconstruction and Development


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Summary

The key components of the balance of payments are

the current account and the capital account. The

current account is a broad measure of the countrys

international trade balance. The capital account is ameasure of the countrys long-term and short-term

capital investments, including direct foreign

investment and investment in securities (portfolio

investment).


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Countrys international trade flows are affected by

inflation, national income, government restrictions,

and exchange rates. High inflation, a high national

income, low or no restrictions on imports, and astrong local currency tend to result in a strong

demand for imports and a current account deficit.

Summary


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A countrysinternational capital flows are affected by

any factors that influence direct foreign investment

or portfolio investment. Direct foreign investment

tends to occur in those countries that have norestrictions and much potential for economic growth.

Portfolio investment tends to occur in those

countries where taxes are not excessive, where

interest rates are high, and where the localcurrencies are not expected to weaken.

Summary

int. flow of fund

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