Balance of Payment Overview

Balance of Payment (BOP)

• BOP is an accounting statement summarizing international economic transactions between a home country and other countries.
• Inflows are recorded as credits (receipts) with a positive sign.
• Outflows are recorded as debits (payments) with a negative sign.

BOP Categories

• Current Account: Records flows of goods, services, and transfers.
  • Trade Account: Exports (goods/services) - Imports (goods/services)
  • Investment Income: Return on investments (e.g., deposits, securities, FDI).
  • Unilateral Transfers: Foreign aid/remittances (official/private).
• Capital Account: Records flows from public and private investment and lending.
  • Private Investments: FDI (foreign direct investment), Portfolio investment (FI)
  • Official lending
  • Debit Repayments
• Official Reserve Account: Measures changes in holdings of gold and foreign currencies.
  • Decrease
  • Increase

Macroeconomic Accounting Identities

• National Income = Consumption + Savings
• National Spending = Consumption + Investment
• National Income – National Spending = Savings – Investment
• National Income – Domestic Spending = Exports
• National Spending – Domestic Spending = Imports
• National Income – National Spending = Exports – Imports
• Savings - Investment = Net Foreign Investment (X - M)
  • When Savings > Investment (S > I), X > M, meaning Current Account Surplus.
  • Conversely (S < I), X < M, meaning current account deficit

Coping with Current Account Deficits

• Currency Devaluation: If a country's current account deficit (X < M), devaluing its currency will make its exports cheaper and imports more expensive, potentially correcting the deficit.
• Protectionism: Governments may impose tariffs or quotas to reduce imports, but this action might provoke retaliation from other countries.

Factors Affecting International Trade Flows

• Inflation: Increased inflation in a country typically leads to a decrease in its current account balance as imports increase and exports decrease due to pricing competitiveness.
• National Income: Increased national income usually leads to a decrease in the current account because imports rise as purchasing power (income) is increased
• Government Restrictions: Tariffs and quotas imposed by a country can reduce imports, but other countries may retaliate with similar measures.
• Exchange Rates: A rising value of a currency typically reduces a country's current account balance as imports increase and exports decrease. The interplay of these factors leads to a complex balance-of-trade scenario.

Factors Affecting DFI (Direct Foreign Investment)

• Changes in Restrictions: Removal of government barriers creates new investment opportunities.
• Privatization: Selling off government operations can boost foreign direct investment.
• Potential Economic Growth: Countries with high economic growth potential attract more foreign investment.
• Tax Rates: Lower corporate tax rates encourage foreign investment
• Exchange Rates: The expectation of a strengthening local currency can attract foreign direct investment.

Factors Affecting International Portfolio Investment

• Tax Rates on Interest or Dividends: Investors prioritize countries with lower tax rates on interest and dividends.
• Interest Rates: Higher interest rates attract capital flows.
• Exchange Rates: Foreign investors are attracted by the possibility of currency appreciation.

Agencies that Facilitate International Flows

• International Monetary Fund (IMF): Promotes international monetary cooperation, exchange stability, economic growth, and provides temporary financial assistance during imbalances of payments.
• World Bank Group: Fosters economic development, primarily by assisting the poorest countries and people.
• World Trade Organization (WTO): Deals with the global rules of trade between nations to ensure smoother, more predictable, and freer trade flows. Its functions include administering trade agreements, serving as a forum for trade negotiations, handling trade disputes, monitoring national trading policies, providing technical assistance for developing countries, and cooperating with other international bodies.
• Regional development Agencies: Focus on regional economic development (e.g., Inter-American Development Bank, Asian Development Bank).