THE BALANCE OF PAYMENTS ACCOUNTS

J A N Á Č I K O V Á N I K O L A TA K Á Č O V Á L U C I A

BOP – WHAT IS IT?

The balance of payments (BOP) is the method countries use to monitor all international monetary transactions at a specific period of time. Usually, the BOP is calculated every quarter and every calendar year.

All trades conducted by both the private and public sectors are accounted for in the BOP in order to determine how much money is going in and out of a country.

Rule : Sell something to rest of world, receive payment - enters as credit (+). Buy something from rest of the world, make payment - enters as debit (-).

THREE TYPES OF INTERNATIONAL TRANSACTION ARE RECORDED IN THE BALANCE OF PAYMENTS

The BOP is divided into three main categories: 1. The current account 2. The capital account exports or imports of goods or services transfers of wealth between countries 3. The financial account purchases or sales of financial assets Within these three categories are sub-divisions, each of which accounts for a different type of international monetary transaction.

Think: All international transactions require foreign currency. All credit transactions give rise to supply of foreign exchange. All debit transactions give rise to demand for foreign exchange

1. THE CURRENT ACCOUNT

The current account is used to mark the inflow and outflow of goods and services into a country.

Earnings on investments, both public and private, are also put into the current account.

For example:When a French consumer imports American blue jeans, for example, the transaction enters the U.S.

balance of payments accounts as a credit on the current account.

• The balance of the current account tells us if a country has a deficit or a surplus.

2. THE CAPITAL ACCOUNT

The capital account is where all international capital transfers are recorded. This refers to the acquisition or disposal of non financial assets and non-produced assets, which are needed for production but have not been produced, like a mine used for the extraction of diamonds.

The capital account is broken down into the monetary flows branching from debt forgiveness, the transfer of goods, and financial assets by migrants leaving or entering a country, the transfer of ownership on fixed assets, the transfer of funds received to the sale or acquisition of fixed assets, gift and inheritance taxes, death levies and, finally, uninsured damage to fixed assets.

3. THE FINANCIAL ACCOUNT

In the financial account, international monetary flows related to investment in business, real estate, bonds and stocks are documented. Also included are government-owned assets such as foreign reserves, gold, special drawing rights held with the International Monetary Fund (IMF), private assets held abroad and direct foreign investment. Assets owned by foreigners, private and official, are also recorded in the financial account.

PAIRED TRANSACTIONS

• •

Every international transaction enters the balance of payments twice, once as a credit and once as a debit If you buy something from a foreigner, you must pay her. She must then spend or store your payment.

5 EXAMPLES OF PAIRED TRANSACTIONS

1. A U.S. citizen buys a $1000 typewriter from an Italian company, and the Italian company deposits the $1000 in its account at Citibank in New York.

• That is, the U.S. trades assets for goods.

This transaction creates the following two offsetting entries in the U.S. balance of payments: • • It enters the U.S.

CA

with a negative sign (-$1000 import).

It shows up as a $1000 credit in the U.S. financial account. ($1000 inflow to CitiBank).

5 EXAMPLES OF PAIRED TRANSACTIONS

2. A U.S. citizen pays $200 for dinner at a French restaurant in France by charging his Visa credit card.

 That is, the U.S. trades assets for services.

• • This transaction creates the following two offsetting entries in the U.S. balance of payments: DOPLŇTE FILL It enters the U.S.

CA

with a negative sign (-$200 import).

It shows up as a $200 credit in the U.S. financial account .

( the French have lent us $200)

5 EXAMPLES OF PAIRED TRANSACTIONS

3. A U.S. citizen buys a $95 newly issued share of stock in the United Kingdom oil giant British Petroleum (BP) by using a check drawn on his stockbroker money market account. BP deposits the $95 in its own U.S.

bank account at Second Bank of Chicago.

 That is, the U.S. trades assets for assets.

This transaction creates the following two offsetting entries in the U.S. balance of payments: DOPLŇTE FILL • • It enters the U.S. financial account with a negative sign ( $95, a financial outflow).

The check shows up as a $95 credit in the U.S. financial account. ( (+$95, a financial

inflow

to Citibank).

5 EXAMPLES OF PAIRED TRANSACTIONS

4. U.S. banks forgive $5,000 in debt owed to them by the government of the imaginary country of Bygonia.

United States makes a $5,000 capital transfer to Bygonia, which appears as a $5,000 debit entry in the capital account. The associated credit is in the financial account, in the form of a $5,000 reduction in U.S. assets held abroad (a negative “acquisition” of foreign assets, and therefore a balance of payments credit ): • • U.S. banks’ debt forgiveness (Capital account, U.S. transfer payment), 5000 Reduction in banks’ claims on Bygonia (Financial account, U.S. asset sale), +5000

5 EXAMPLES OF PAIRED TRANSACTIONS

5. Suppose we buy from the Austrian company Karcher Vacuums device worth € 2,500. Our payment for the purchase of the machine from the Austrian seller enters the SVK current account (in this case it will be a transaction type import) as a debit (payment abroad). The question is where credit is factored in (foreign income) balance of payments ?

Purchase machine (Current Account, SVK good import) Sale of the bank VUB (Financial Account, SVK asset sale) Credit 2500€ Debit 2500€

ZDROJE:

1. Krugman P., Obstfeld M.,Melitz M.: economics: theory and policy. Boston : Pearson Addison-Wesley, 2012.

International 2. www.investopedia.sk