BOP

1. BOP Lerzan Özkale N. Lerzan Özkale

2. BALANCE OF PAYMENTS(BOP) • The record of a country’s transactions in goods, services and assets with the rest of the world is its balance of payments. • The BOP is also the record of a country’s sources (supply) and uses (demand) of foreign exchange. • The distinction between the balance of payments and a balance sheet: • A balance sheet for a firm measures its stock of assets and liabilities at a moment in time. • The balance of payments, by contrast, measures flows, usually over a period of a month, a quarter, or a year. N. Lerzan Özkale

3. BOP BOP records economic transactions between the residents and government of a particular country and the residents and governments of the rest of the world. Concept of Residency In BOP accounting, an individual may be a resident of one country and a citizen of another (roughly after 18 months). A firm may be resident in a country other than the country in which its headquarters is located. This means that their transactions with other residents of the countries in which they reside ordinarily do not have BOP effects. Even for their payments in the money of their own country, they are considered as foreign resident because their holdings of their home country’s currency are considered foreign-held by their home country. But government employees residing in a foreign country are not considered resident of this country. N. Lerzan Özkale

4. BOP Transaction Concept Most BOP transactions involve current or future money flows, but there are some exceptions: • Barter trade • Shipment of equipment to foreign subsidiaries by the corporations for increasing their investments abroad: no payment. The merchandise trade is affected without offsetting flow of money. • Unilateral transfers: • government grants, pension payments etc. • Profits of a subsidiary which the parent company allows the subsidiary to retain. The profits are not remitted to the parent so no actual transaction occurs. But, it is general practice to present reinvested earnings of subsidiaries in the BOP as if they were remitted to the parents and returned to the subsidiaries. N. Lerzan Özkale

5. BOP Statistical Disrepancy Account • Time lags • Changes in recording procedures • Random variations in unrecorded transactions • Underground Economy Hypothesis • Over or under statement of the current account deficit problems of under or overinvoicing in foreign trade • Under statement of the exports and investment income • Understatement of net capital inflows / outflows • The role of exchange rates (ER differences in time) N. Lerzan Özkale

6. Estimated Size of the Underground (hidden) Economy (% of GNP) Poland 34 Denmark 16 Netherlands 8 Hungary 31 Finland 11 Australia 7 Spain 21 Germany 11 France 6 Greece 20 USA 10 Norway 5 Italy 16 UK 10 Japan 3 N. Lerzan Özkale

7. BOP CURRENT ACCOUNT Trade in goods: Exports (credit (+) item on the current account) FOB Imports (debit (-) item on the current account) CIF Trade in services: (freight, insurance etc) BALANCE OF TRADE Investment income (dividends, interest, rent, profits from Foreign assets holdings like stocks, bonds or from real assets: building, factories) Investment payments Net transfer payments and other ( a check to a parent abroad, a check by the government to a retiree living in another country+ interest paid by the government to foreigners) BALANCE ON CURRENT ACCOUNT N. Lerzan Özkale

8. BOP CAPITAL ACCOUNT For each transaction recorded in the current account, there is an offsetting transaction recorded in the capital account. Ex: A US citizen purchasing a Japanese car Yen/Dollar ER = 125 yen/dollar Price of the car= 2.5 million yen = $ 20.000 The US citizen takes $ 20.000, buys 2.5 million yen and buys the car. BOP: Imports increased by $ 20.000 in the current account Foreign assets in the US (Japanese holdings of US $) are increased by $ 20.000 in the capital account. The net wealth position of the US vis-a vis the rest of the world has decreased by $ 20.000. N. Lerzan Özkale

9. BOP An increase in the US imports results in an increase in foreign assets in the US. The US must pay for the imports and whatever it pays with (in this example, in US dollars), is an increase in foreign assets in the US. Conversely, an increase in US exports results in an increase in US assets abroad, because foreigners must pay for the US exports. N. Lerzan Özkale

10. US BOP of 1997All transactions bringing forex into US are credited (+) to the CAAll transactions causing US to lose forex are debited (-) to the CA CURRENT ACCOUNT billions of US $ Goods exports 682.3 Goods imports -888.5 (1) Net export of goods -206.2 Export of services 257.6 Import of services -170 (2) Net export of services 87.6 Income received on investments 242.4 Income payments on investments -255.7 (3) Net investment income -13.3 (4) Net transfer payments and other -36.8 (5) Balance on current account (1+2+3+4) -168.7 N. Lerzan Özkale

11. US BOP ( cont’d) CAPITAL ACCOUNT (6) Change in private US assets abroad (increase is -) -405.3 (7) Change in foreign private assets in US 588.2 (8) Change in US gov. assets abroad (increase is -) -1.0 (9) Change in foreign gov. assets in the US 90 (10) Balance on capital account (6+7+8+9) 271.9 (11) Statistical disrepancy -103.2 (12) Balance of Payments (5+10+11) 0 N. Lerzan Özkale

12. National Saving, Investment, and the Current Account National income accounting identity is: Y = C + I + G + X WHERE Y : national income or GDP (Gross Domestic Product) C : consumption G : government expenditures (spending) X : net exports (exports minus imports sometimes also referred as X - M) N. Lerzan Özkale

13. National Saving, Investment, and the Current Account Y - C - G = S = I + X WHERE S : national saving This equation indicates that national saving is equal to the sum of investment spending plus the current account (CA) (net exports), which implies that the CA must be equal to the national saving (S) minus investment spending (I): X = S - I N. Lerzan Özkale

14. National Saving, Investment, and the Current Account X = S - I If domestic saving S > I CA surplus (positive X) If domestic saving S < I CA deficit (negative X) N. Lerzan Özkale

15. National Saving, Investment, and the Current Account A country where spending is greater than income has investment greater than saving, and a current account deficit. The excess of spending over income must be financed by foreign investment, so there will be a capital account surplus to match the current account deficit. N. Lerzan Özkale

16. National Saving, Investment, and the Current Account The BOP values are affected by changes in international spending and saving behaviour. This behaviour may be • on the part of households and business firms (private sector) • or on the part of government (public sector) N. Lerzan Özkale

17. National Saving, Investment, and the Current Account There are two kinds of saving: private : Y - T - C T: Taxes government : T - G National saving is equal to private saving plus government saving. S = (Y - T - C) + (T - G) N. Lerzan Özkale

18. National Saving, Investment, and the Current Account S = (Y - T - C) + (T - G) +/- +/- For many years, for the US the first one was +, the second one was - Government saving is the negative of government budget deficit. N. Lerzan Özkale

19. National Saving, Investment, and the Current Account A government spending more than its tax revenue creates government dissaving and contribute to a larger CA deficit. The CA deficit and Capital Account surplus could be reduced by reducing the government budget deficit so that government dissaving falls. National income, spending and national saving are closely related with BOP. N. Lerzan Özkale

20. National Saving, Investment, and the Current Account Reducing the current account deficit requires: • increasing domestic saving relative to investment and • increasing domestic output relative to domestic spending. N. Lerzan Özkale

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