BALANCE OF PAYMENT

UNDERSTANDING -ANALYSIS -INTERPRETATION

INTRODUCTION
The statistical record of a countrys international
transactions over a certain period of time presented in
the form of double-entry book-keeping.
In BoP, any transaction resulting in a receipt from
foreigners is recorded as a credit, with a positive sign
any transaction resulting in a payment to foreigners is
recorded as a debit, with a minus sign

CASE #1
The Boeing Corporation exported a Boeing 747 aircraft
to Japan Airlines for $50 Mn, and that Japan Airlines
pays from its dollar bank account kept with Chase
Manhattan Bank in New York City. Then, the receipt of
$50 Mn by Boeing will be recorded as a credit (+), which
will be matched by a debit (-) of the same amount
representing a reduction of the U.S. banks liabilities.

CASE #2
Boeing imports jet engines produced by Rolls-Royce for
$30Mn and that Boeing makes payment by transferring
the funds to a New York bank account kept by RollsRoyce. In this case, payment by Boeing will be recorded
as a debit (-), whereas the deposit of the funds by RollsRoyce will be recorded as a credit (+).

CASE #3
Ford acquires Jaguar, a British car manufacturer, for
$750 Mn and Jaguar deposits the money in Barclays
Bank in London, which, in turn, uses the sum to purchase
U.S> treasury notes. In this case, the payment of $750 Mn
by Ford will be recorded as a debit (-) whereas Barclays
purchase of the US Treasury notes will be recorded as a
credit (+)

ACCOUNT
Transactions
Boeings export

Credit

Debit

+ $50 million

Withdrawal from US Bank

- $50 million

Bowings import

- $30 million

Deposit at US bank

+ $30 million

Fords acquisition of Jaguar

Barclays purchase of US securities
Balance of Payment

- $750 million
+$750 million
$ 830 million

$ 830 million

COMPOSITION
A countrys international transactions can be grouped
into three main categories:
The current account
The capital account
The official reserve account

THE CURRENT ACCOUNT

It includes
Exports and imports of goods
Exports and imports of services

Divided into four subcategories:

Merchandise trade
Represents exports and imports of tangible goods,
Services
Receipts and payments for legal, engineering, consulting and
other performed services and tourist expenditures
Factor income
Payments and receipts of interest, dividends and other income
on previously made foreign investments
Unilateral transfers
Unrequited payments such as gifts, foreign aid, and reparations

THE CAPITAL ACCOUNT

It includes:
All purchases and sales of assets such as stocks, bonds,
bank accounts, real estate and businesses

Divided into three sub-categories:

Direct investment
Acquisitions of controlling interests in foreign businesses
Portfolio investment
Investments in foreign stocks and bonds that do not involve
acquisitions of control
Other investment
Includes Bank deposits, Currency investment, Trade credit etc

THE OFFICIAL RESERVE ACCOUNT

It includes:
All purchases and sales of international reserve assets, such
as dollars, foreign exchanges, gold and SDRs.

Computing the cumulative balance of payments

including the current account, capital account, and the
statistical discrepancies, we get overall balance or
official settlement balance
It is indicative of a countrys BoP gap that must be
accommodated by official reserve transactions.
If a country must make a net payment to foreigners
because of a BoP deficit, the country should run down its
official reserve assets such as gold, foreign exchanges
and SDRs or borrow a new from foreigners.

ANALYSIS WITH AN EXAMPLE

US exports were $2116 Bn in 2009 while US imports were
$2405.6 billion. The current account balance, which is
defined as exports minus imports plus unilateral transfers,
that is, (1) +(2) + (3) was negative -$419.8 Bn. The US thus
had a balance-of-payments deficit on the current
account in 1009. the current account deficit implies that
the United States used up more output than it produced.

CONTD.
Credit

Debit

Current Account
1. Exports

2116.0

1.1 Merchandise

1050.0

1.2 Services

504.8

1.3 Factor Income

561.2

2. Imports

-2405.6

2.1 Merchandise

-1562.7

2.2 Services

-370.7

2.3 Factor Income

-472.2

3. Unilateral transfer
Balance on Current Account (1 + 2 + 3)

19.2

-149.4
-419.8

CONTD.
Credit

Debit

4. Direct investment

152.1

-221.0

5. Portfolio investment

376.6

-549.4

5.1 Equity securities

141.9

-68.6

5.2 Debt securities

234.7

-480.8

6. Other investment

616.3

-93.5

Balance on capital account (4 + 5 + 6)

281.1

7. Statistical Discrepancies

192.8

Capital Account

Overall balance
Official Reserve Account

52.2
-52.2

INTERPRETATION
A country can run BoP surplus or deficit by increasing or
decreasing its official reserves.
Under the fixed exchange rate regime , the combined
balance on current and capital accounts will be equal
in size, but opposite in sign, to the change in the official
reserves. Under the pure flexible exchange rate regime
where the central bank does not maintain any official
reserves, a current account surplus or deficit must be
matched by a capital account deficit or surplus.

PRACTICE QUE.
1. Define Balance of Payments.
2. Why would it be useful to examine a countrys balance-ofpayments data?
3. Comment on the statement: Since the United States imports
more than it exports, it is necessary for United States to import
capital from foreign countries to finance its current account
deficits.
4. Explain how a country can run an overall balance-ofpayments deficit or surplus.
5. Explain official reserve assets and its major components.