International Financial Management: INBU 4200 Fall Semester 2004

1
International Financial Management INBU
4200Fall Semester 2004

• Lecture 5 Part 2
• Balance of Payments
• (Chapter 3)

2
The Balance of Payments

• Balance of Payments (BOP)
• A measurement of all international economic and
  financial transactions between the residents of a
  country and foreign residents.
• The International Monetary Fund (IMF) is the
  primary source of similar statistics worldwide.
• Think of a countrys BOP as a country cash flow
  account (statement) NOT as a balance sheet.
• Represents transactions over some period of time

3
Use of BOP Data by Businesses

• Multinational businesses use BOP measures to
  assess the growth and health of specific types of
  trade or financial transactions by country.
• BOP helps to forecast a countrys market
  potential where business may opportunities
  exist.
• What are countrys buying (imports), selling
  (imports), etc.
• BOP is important indicator of potential pressure
  on a countrys exchange rate.
• Surplus countries generally have strong
  currencies.
• Deficit countries generally have weak currencies.
• Thus, BOP indicates suggests the potential
  exposure from international activities.
• Or, the potential losses or gains from foreign
  currency exposed positions of business firms.

4
Two Types of BOP Transactions

• Cross Border purchase (or Sale) of Real Assets
• Goods
• Cars, computers, clothing, agricultural products,
  industrial products
• Services
• Banking, consulting, air travel, student exchange
  programs, foreign workers.
• Enterprises
• Cross border acquisitions of companies in other
  countries.

• Cross Border purchase (or Sale) of Financial
  Assets
• Equity
• Stocks
• Debt
• Bonds, bank loans.

5
Balance in the BOP

• While individual components in a countrys BOP
  are likely to out of balance, the overall BOP
  must be in balance.
• Why?
• Transactions recorded using a double-entry
  accounting bookkeeping methodology (in theory).
• Thus, in theory, each BOP transaction should be
  recorded as both a debit and a credit entry.
• In reality the two transactions are recorded
  independently
• Thus, the debits and credits are not likely to be
  equal.
• BOP is balances through an errors and omissions
  account.

6
Debit or Credit Transactions

• Basic Rule to determine debit or credit BOP
  transaction.
• Follow the flow of money!
• If money is flowing out of a country, it is
  recorded as a debit transactions, and hence a BOP
  deficit.
• If money is flowing into a country, it is
  recorded as a credit transaction, and hence a BOP
  surplus.

7
Example of BOP Flows

• Japan Airlines purchase aircraft from Boeing
  (United States)
• From U.S. BOP standpoint Sale of real asset.
• Money inflow to U.S. manufacturer Credit
  transaction.
• Aircraft exports from the U.S. Surplus
  transaction
• From Japans BOP standpoint Purchase of real
  asset.
• Money outflow from Japan Debit transaction.
• Aircraft imports from the U.S. Deficit
  transaction

8
Example of BOP Flows

• British company acquires a U.S. company.
• From U.S. BOP standpoint Sale of real asset.
• Money flow to U.S. company (shareholders) Credit
  transaction.
• Foreign direct investment in U.S. Surplus
  transaction.
• From U.K.s BOP standpoint Purchase of real
  asset.
• Money outflow from U.K. company (shareholders)
  Debit transaction.
• Foreign direct investment overseas Deficit
  transaction

9
Example of BOP Flows

• Canadian worker in U.S. sends money home to
  family in Vancouver, B.C..
• From U.S. BOP standpoint remittances abroad.
• Money outflow from U.S. Debit transaction.
• Net transfer abroad. Deficit transaction.
• From Canadas BOP standpoint remittances from
  abroad.
• Money inflow from U.S. Credit transaction.
• Net transfer (from) abroad Surplus transaction.

10
Balance of Payments Accounts

• The BOP is divided into two major accounts
• the Current Account and the Capital/Financial
  Account.
• Current Account tracks
• Balance of Trade (net) merchandise exports and
  imports.
• Services Balance (net) financial services and
  travel (other) services
• Financial Provided by banks to non-residents.
• Travel/other Provided by domestic entities to
  foreign country residents, such as meals, hotels,
  air travel, student exchanges, construction.
• Income Balance (net) investment income from
  abroad and to foreign entities (arises from
  previous investments).
• Net Transfers (net) private remittances to
  residents abroad (money/gifts) or by governments
  (aid).

11
Balance of Payments Accounts

• Capital/Financial Account captures cross border
  investments during the recorded period. These
  include
• Purchases (or sales) of real estate.
• (net) Direct investment (FDI).
• FDI in the U.S. minus U.S. FDI abroad (positive
  number if net direct investment into the U.S.
  and thus capital inflow)
• (net) Portfolio investment
• Non-controlling equity investments (lt10)
• Debt investments.
• Either personal or institutional (mutual funds)
• Portfolio investment in the U.S. minus U.S.
  portfolio investment abroad (positive number if
  net portfolio investment in the U.S. and thus
  capital inflow).
• (net) Other financial transactions
• Bank loans, trade credit

12
Other BOP Accounts

• Two additional BOP accounts are
• Official Reserve Account tracks the transactions
  by the official monetary authorities (central
  bank and treasury department) of a country
• Increase in international reserves (major
  currencies of the world dollar, yen, euro,
  gold).
• Net Errors and Omissions Balancing account
  included because transactions are collected
  individually (double entry bookkeeping in theory).

13
Current and Capital Account

• The two major sub-accounts of the BOP, the
  Current and Financial Account, summarize the
  current trade and international capital flows of
  the country respectively
• The Current and Financial Account are typically
  inverse, i.e., one in surplus while the other is
  in deficit
• In fact, a deficit in a countrys current account
  needs to be financed through a surplus in its
  financial account!
• If not, pressures will be placed on the exchange
  rate!
• Issuing facing the United States today!
• Reason for the U.S. dollar performance of late!

14
Current and Financial/Capital Account Balances
for the United States, Annual Data 1992-99
(billions of US)
Source International Monetary Fund, Balance of
Payments Statistics Yearbook, 2000.
15
Response of Exchange Rate to 1997 and 1998 U.S.
Current and Capital Account Imbalance.

• Note Relate back to previous slide.

16
Thailands BOP in the 1990s
Source International Financial Statistics,
International Monetary Fund, Washington DC,
monthly.
17
Thai Baht in 1997
18
SOURCE OF BOP DATA

• The Economist
• Trade Balance, Current Account Balance and
  Forecasts
• Economic and Financial Indicator Section
• OECD Country data (Current Account)
• http//www.oecd.org/LongAbstract/02C25462Cen_264
  9_33715_2487499_119656_1_1_12C00.html