The Balance of
Payments
Chapter 7
5.1 Introduction:
• A country’s balance of payments (BOP) is a systematic
record of all the economic transactions between the residents
of the country and the residents of other countries during a
specific period of time , usually a calendar year.
• The main purpose of the balance of payments is to inform the
government of the international position of the country and to
help it in its formulation of monetary, fiscal, and commercial
policies .
This definition of the balance of payments requires some
clarification
• First of all, it is obvious that the millions of transactions
of the residents of a country with the rest of the world
cannot appear individually in the balance of payments.
• As a summary statement , the balance of payments
aggregates all transactions (Merchandise trade for
example) into a few major categories .
• Secondly, An international economic transaction refers to the
exchange of a good , a service , or an asset (for which payment is
normally required ) between the residents of one country and the
residents of other countries .
• However , gifts and certain other transactions (for which no payment
is required ) are also included in a country’s balance of payments.
• Thirdly, the question of who is a resident of a country also requires some
clarification.
• A resident of the country is a person or a corporation that is subject to laws and
protection of the country where he stays permanently.
• Diplomats , military personnel , workers who temporarily migrate , and tourists
are residents of the country in which they hold citizenship .
• Similarly, a corporation is the resident of the country in which it is incorporated ,
but its foreign branches and subsidiaries are not .
• International institutions such as United Nations , the International Monetary Fund
(IMF) , the World Bank are not residents of the country in which they are located.
• Fourthly, the balance of payments has also a time dimension.
Thus , it is the flow of goods , services , gifts , and assets
between the residents of a country and the residents of other
countries during a particular period of time , usually a
calendar year .
5.2 Accounts or components of the balance of payments:
• The balance of payments consists of three main accounts. They are the Current
Account , the Capital Account , and the Official Settlements Account.
• Each transaction is entered in the balance of payments as a credit or a debit .
A credit transaction is one that leads to the receipts of a payment from foreigners .
A debit transaction leads to a payment to foreigners.
5.2.1 The Current Account:
• The current account includes the value of trade in merchandise , services
, and unilateral transfers.
• Merchandise is the trade in tangible goods (commodities).
• Services include travel and tourism , transportation costs, insurance
services, incomes and payments on investments, costs of diplomatic and
military missions, and remittances of workers abroad .
• Unilateral transfers refer to gifts and grants made to foreigners and those
received from them.
• The export of goods and services and the receipt of unilateral transfers
(gifts and grants) are entered in the current account as credits (+) because
they lead to the receipt of payments from foreigners .
• On the other hand , the import of goods and services and the payment of
unilateral transfers are entered as debits (-) because they lead to payments
to foreigners .
To Sum up Current Account:
Current account is the sum of the balance of trade, includes:
Imports (debit) -ve
Exports (credit) +ve
Net services( transportation )
Unilateral transfers (gifts, foreign aid, workers
remittances)
• Total balance-of-payments account Must always be in balance
• Surplus means that Balance on a subaccount (subaccounts) is positive
• Deficit means that Balance on a subaccount (subaccounts) is negative
5.2.2 The Capital Account:
• The capital account shows the flows of international investments and
loans ,both long term and short term .
• Long-term international capital transactions refer to transactions with
maturity of one year or more and include direct investments (such as the
building of foreign plant or factory), portfolios investments (such as the
purchase of foreign stocks and bond ), and international loans for one year
or more .
• International capital movements (both long term and short term) are also
divided into private and official , and non liquid (such as foreign bank loans
to finance trade) and liquid (such as foreign bank deposits).
Capital inflows can take one of the two forms:
• An increase in foreign assets in the country or the reduction in the country
assets abroad. For example, when a foreigner purchases an Egyptian stock,
foreign assets in Egypt increase, this is a capital inflow to Egypt and is
recorded as a credit in Egypt’s balance of payments because it involves the
receipt of payments from a foreigner.
• A capital inflow can also take the form of a reduction in the country’s assets
abroad For example ; when an Egyptian sells a foreign stock , Egypt’s assets
abroad decrease, this is a capital inflow to Egypt.
• On the other hand , capital outflows can take the form of either an increase
in the country’s assets abroad or a reduction in foreign assets in the
country because both involve a payment to foreigners.
• To summarize ,when capital transactions lead to the receipt of payments
from foreigners , they are capital inflow and entered as credits (+) .
• However ,when these transactions lead to foreigners , they are capital
outflows and entered as debits (-).
3- Official Settlment:
• Official settlements transactions such as
- Movement of financial assets among official holders
- Official reserve assets
-Liabilities to foreign official agencies
Statistical discrepancy
• Errors and omissions
Example:
Find the official settlements balance and the basic balance of payments for USA
(assume fixed exchange rate)
Imports 60
U.S income from foreign investment 10
Other services, net -20
Increase in short term foreign claims on the U.S 20
Increase in U.S official reserve assets 20
Exports 50
Foreign purchases of U.S securities 25
U.S direct investment abroad 15
Increase in official U.S liabilities to foreign official agencies 40
U.S purchases of foreign securities 20
Foreign income from U.S investments 15
Foreign direct investment in the U.S 20
U.S gifts and remittances to foreigners 15
Foreign gifts and remittances to the U.S 25