Unit 3

Balance of Payment

Sanjay Ghimire

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 Contents

– Typical balance of payments transactions;

– Accounts of balance of payments;
– Capital and financial account;
– Balance of payments in total

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 Typical Balance of Payments Transactions

● International transactions take many forms.

– Honda U.S. is the U.S. distributor of automobiles manufactured in
Japan by its parent company, Honda of Japan.
– A U.S.-based firm, Fluor Corporation, manages the construction of a
major water treatment facility in Bangkok, Thailand.
– The U.S. subsidiary of a French firm, Saint Gobain, pays profits
(dividends) back to its parent firm in Paris.
– An American tourist purchases a small Lapponia necklace in
Finland.
– The U.S. government finances the purchase of military equipment
for its NATO (North Atlantic Treaty Organization) military ally,
Norway.
– A Mexican lawyer purchases a U.S. corporate bond through an
investment broker in Cleveland.
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 Balance of Payments
● The balance of payments is a summary of transactions
between domestic and foreign residents for a specific
country over a specified period of time.
● The Balance of Payments is the statistical record of a
country’s international transactions over a certain period
of time presented in the form of double-entry
bookkeeping.
● Defining International Economic Transactions
– Goods, Services, Capital and Transfers
● The BOP as a Flow Statement
– The BoP is often misunderstood as people infer from its name
that it is a Balance Sheet, whereas it is a cash flow statement.
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 Balance of Payments

● Two major importance of BoP

– The balance of payments provides detailed information
concerning the demand and supply of a country’s currency
– A country’s balance-of-payment data may signal its potential
as a business partner for the rest of the world.
– Balance-of-payments data can be used to evaluate the
performance of the country in international economic
competition.

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 Balance of Payments Accounting

● BOP Accounting
– BoP is based on double entry bookkeeping system
– Inflows of funds is reported as positive and generate credits for the
country’s balance, while outflows of funds is reported negative and
generate debits.
● Balancing BoP
– Balance of payment must balance.
– It cannot be in disequilibrium unless something has not been counted
improperly.
– Therefore it is incorrect to state that the BoP is in disequilibrium.
● Surplus VS deficit of BoP
– By definition, the overall BoP must balance
– Current account balance + capital account balance + official reserve
6 account = BoP = 0
 Balance of Payments Accounting

● Credit entries in balance of payments result from foreign sales of

goods and services, goodwill, financial claims, and real assets.
● Debit entries, on the other hand, arise from purchases of foreign
goods
● and services, goodwill, financial claims, and real assets.
● Further, credit entries give rise to the demand for home currency,
whereas debit entries give rise to the supply of home currency.
● Note that the demand (supply) for home currency is associated
with the supply (demand) of foreign (currency) exchange.
● Since the balance of payments is presented as a system of
double-entry bookkeeping, every credit in the account is balanced
by a matching debit and vice versa.
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 Balance of Payments Accounting
• Suppose that Boeing Corporation exported a Boeing 747 aircraft to Japan Airlines
for $50 million, and that Japan Airlines pays from its dollar bank account kept
with Chase Manhattan Bank in New York City. Then, the receipt of $50 million 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. bank’s liabilities.
• Suppose, for another example, that Boeing imports jet engines produced by
Rolls-Royce for $30 million, and that Boeing makes payment by transferring the
funds to a New York bank account kept by Rolls-Royce. In this case, payment by
Boeing will be recorded as a debit (−), whereas the deposit of the funds by
Rolls-Royce will be recorded as a credit (+).
• Suppose that Thomson Corporation, a U.S. information services company,
acquires Reuters, a British news agency, for $750 million, and that Reuters
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 million by
Thomson will be recorded as a debit (−), whereas Barclays’ purchase of the U.S.
Treasury notes will be recorded as a credit (+).

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 The Accounts of the Balance of Payments

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 The Accounts of the Balance of Payments

● The Current Account

– Goods trade: Import and Export of goods.
– Services trade: Import and Export of services
– Income: (Receipt and payment of dividend and
interest; and wages and salaries paid to nonresident
workers)
– Current transfers. gift or grant, remittance by
migrant and permanent worker.
– The Current Account is typically dominated by the
first component which is known as the Balance of
10 Trade (BoT) even though it excludes service trade
 ● Capital Account
– The capital account is made up of transfers of
financial assets and the acquisition and disposal
of nonproduced/ nonfinancial assets.
– This account has been introduced as a separate
component in the IMF’s balance of payments only
recently.
– The magnitude of capital transactions covered is
relatively minor

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 ● The Financial Account
– Measures all international economic transactions
of financial assets. It consists following
sub-categories:
● Direct investment: in which the investor exerts some
explicit degree of control over assets.
● Portfolio investment: in which the investor has no control
over the assets.
● Other Investment: consists of various short and
long-term trade credits, cross border loan, currency
deposits, bank deposits, and other A/R and A/P related
12 to cross-border trade.
 Balance of Payment

● The Official Reserve Account

– Records foreign asset transactions of a country
and foreign central banks
– International or Official reserves
● Holdings of foreign currency denominated assets by
central banks, including
– Gold
– Government holdings of foreign exchanges,
– Special drawing right (SDR)
– Reserve position in IMF

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 ● Net Errors and Omissions.
● Current and financial account entries are
collected and recorded separately, errors or
statistical discrepancies will occur.
● The net errors and omissions account
ensures that the BOP actually balances.

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 Balance of Payment in Total

● The BoP in total – Surplus:

– A surplus in BoP implies that the demand for the country's
currency exceeded the supply and that the government should
allow the currency value to increase or intervene and ensure
higher supply of domestic currecy.
● The BoP in Total – Deficit
– Implies an excess supply of the county’s currency on world
markets, and the government should then either devalue the
currency or expand its official reserve to support its value
– A country is more likely to have a deficit in its current account,
the higher its price level, the lower its barriers to imports.

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The Balance of Payments Identity

BCA + BKA + BRA = 0

where
BCA = balance on current account
BKA = balance on capital account
BRA = balance on the reserves account

Under a pure flexible exchange rate regime,

BCA + BKA = 0
 Nepalese Balance of Payments
2020/21 (9 Month) 2019/20 2018/19
Current Account Credit Debit Credit Debit Credit Debit
1 Goods 822 -9212 938 -10124 1008 -12392
2 Service 533 -951 1354 -1364 1650 -1787
3 Income 412 -290 588 -189 708 -350
4 Transfer 6954 -41 8506 -47 8910 -79
Current Account Balance -1774 -339 -2333
Capital Account
5Capital Transfer 110 123 137
6Direct Investment 105 169 115
7Portfolio Investment 0 0 0
8Other Investment 1474 -360 2179 -53 992 -245
Capital Account
Balance 1329 2418 999
9 Statistical Decripency 678 561 838
Overall Balance 233 2640 -495
 Nepalese Balance of Payments

Current Account Credit Debit

1 Goods 822 -9212
2 Service 533 -951
3 Income 412 -290
4 Transfer 6954 -41
In 20/21, Nepal
imported more
Current Account Balance -1774
than it exported,
Capital Account
thus running a
5Capital Transfer 110
current account
6Direct Investment 105
deficit of $1774
7Portfolio Investment 0
million.
8Other Investment 1474 -360
Capital Account Balance 1329
9 Statistical Decripency 678
Overall Balance 233
Official Reserve Account -233
 Nepalese Balance of Payments

Current Account Credit Debit

1 Goods 822 -9212
2 Service 533 -951
3 Income 412 -290
During the same
4 Transfer 6954 -41
year, the Nepal
attracted net
Current Account Balance -1774
investment of $1329
Capital Account
million —clearly the
5Capital Transfer 110
rest of the world
6Direct Investment 105
found the Nepal to
7Portfolio Investment 0
be a good place to
8Other Investment 1474 -360
invest.
Capital Account Balance 1329
9 Statistical Decripency 678
Overall Balance 233
Official Reserve Account -233
 Nepalese Balance of Payments

Current Account Credit Debit

1 Goods 822 -9212
2 Service 533 -951
3 Income 412 -290
Under a pure flexible
4 Transfer 6954 -41
exchange rate
regime, these
Current Account Balance -1774
numbers would
Capital Account
balance each other
5Capital Transfer 110
out.
6Direct Investment 105
7Portfolio Investment 0
8Other Investment 1474 -360
Capital Account Balance 1329
9 Statistical Decripency 678
Overall Balance 233
Official Reserve Account -233
 Nepalese Balance of Payments

Current Account Credit Debit

1 Goods 822 -9212
2 Service 533 -951
3 Income 412 -290
4 Transfer 6954 -41
Current Account Balance -1774 In the real world,
Capital Account there is a statistical
5Capital Transfer 110 discrepancy.
6Direct Investment 105
7Portfolio Investment 0
8Other Investment 1474 -360
Capital Account Balance 1329
9 Statistical Decripency 678
Overall Balance 233
Official Reserve Account -233
 Nepalese Balance of Payments

Current Account Credit Debit

1 Goods 822 -9212
2 Service 533 -951
3 Income 412 -290
Including that, the
4 Transfer 6954 -41
balance of payments
Current Account Balance -1774
identity should hold:
Capital Account
BCA + BKA = - BRA
5Capital Transfer 110
6Direct Investment 105 ($1774) + $1329 + $678 =
7Portfolio Investment 0 $233= –($233)
8Other Investment 1474 -360
Capital Account Balance 1329 Govt use $233
9 Statistical Decripency 678 million to increase its
Overall Balance 233 reserve position
Official Reserve Account -233
 Nepalese Balance of Payments
Current Account Credit Debit
1 Goods 822 -9212
2 Service 533 -951
3 Income 412 -290
4 Transfer 6954 -41 P S
Current Account Balance -1774
Capital Account
5Capital Transfer 110
6Direct Investment 105
7Portfolio Investment 0
8Other Investment 1474 -360 D
Capital Account Balance 1329
9 Statistical Decripency 678 Exchange rate, Rs.
Overall Balance 233
Official Reserve Account -233
As Nepalese import, they are supply NRs to the FOREX market.
 Nepalese Balance of Payments
Current Account Credit Debit
1 Goods 822 -9212
2 Service 533 -951
3 Income 412 -290
4 Transfer 6954 -41 P S
Current Account Balance -1774
Capital Account
5Capital Transfer 110
6Direct Investment 105
7Portfolio Investment 0
8Other Investment 1474 -360 D
Capital Account Balance 1329
9 Statistical Decripency 678
Exchange rate, Rs.
Overall Balance 233
Official Reserve Account -233
As Nepalese export, others demand NRs at the FOREX market.
 Nepalese Balance of Payments
Current Account Credit Debit As the Nepalese government
1 Goods 822 -9212 sells NRs, the supply of NRs
2 Service 533 -951 increases.
3 Income 412 -290
4 Transfer 6954 -41 P S
Current Account Balance -1774 S1
Capital Account
5Capital Transfer 110
6Direct Investment 105
7Portfolio Investment 0
8Other Investment 1474 -360 D
Capital Account Balance 1329
9 Statistical Decripency 678
Exchange rate, Rs.
Overall Balance 233
Official Reserve Account -233
The situation would be reverse if overall balance is negative
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 Nepalese Balance of Payment
2020/21 (9 Month) 2019/20 2018/19
Current Account Credit Debit Credit Debit Credit Debit

1 Goods 96,769.3 (1,083,568.6) 108,288.1 (1,169,261.4) 113,664.4 (1,398,685.1)

2 Service 62,795.8 (111,925.7) 156,349.5 (157,314.5) 186,371.5 (201,599.2)

3 Income 48,411.3 (34,246.5) 68,041.4 (21,940.1) 79,916.7 (39,945.0)

4 Transfer 819,134.7 (4,778.1) 987,673.5 (5,452.3) 1,005,588.1 (8,941.2)

Current Account
Balance (207,407.7) (33,615.8) (263,629.6)
Capital Account

5 Capital Transfer 12,859.3 14,213.2 15,458.7

6 Direct Investment 12,353.4 - 19,478.7 - 13,064.8

7 Portfolio Investment - -

8 Other Investemt 173,169.0 (42,201.4) 258,105.5 (6,304.4) 110,923.7 (27,539.7)

Capital Account
Balance 156,180.4 285,493.1 111,907.4

9 Statistical Decripency 79,956.5 64,238.4 94,959.2

Overall Balance 28,729.2 316,115.7 (56,763.0)

Official Reserve Account (28,729.2) (316,115.7) 56,763.0