International-Financial-Management-(3)

GSBS6145–Topic3LectureNotesBalanceofPaymentsCategories•Thebalanceofpaymentsisanaccountingstatementthatsummarisesalltheeconomictransactionsbetweenresidentsofthehomecountryandresidentsofallothercountries.•Currencyinflows(sourcesofforex)arerecordedascredits,andoutflows(usesofforex)arerecordedasdebits.•Creditsshowupwithaplussign,anddebitshaveaminussign.BalanceofPaymentsCategories•Thereare3principalbalanceofpaymentscategories:i.Currentaccount,whichrecordsimportsandexportsofgoods,services,incomeandcurrentunilateraltransfersii.Capitalaccount,whichincludesmainlydebtforgivenessandtransfersofgoodsandfinancialassetsbymigrantsastheyenterorleavetheUSBalanceofPaymentsCategoriesiii.Financialaccount,whichshowspublicandprivateinvestmentandlendingactivities.Thenamingofthisaccountissomewhatmisleadingasit,ratherthanthecapitalaccount,recordsinflowsandoutflowsofcapital.•Formostcountries,onlythecurrentandfinancialaccountsaresignificant.BalanceofPaymentsCategories•ExportsofG&Sarecredits;importsofG&Saredebits.•Interestanddividendsaretreatedasservicesbecausetheyrepresentpaymentfortheuseofcapital.•Financialinflowsappearascreditsbecausethenationisselling(exporting)toforeignersvaluableassets–building,land,stock,bonds,andotherfinancialclaims–andreceivingcashinreturn.BalanceofPaymentsCategories•Financialoutflowsshowupasdebitsbecausetheyrepresentpurchases(imports)offoreignassets.•Theincreaseinanation’sofficialreservesalsoshowsupasadebititembecausethepurchaseofgoldandotherreserveassetsisequivalenttoimportingtheseassets.•Thebalanceofpaymentsstatementisbasedondouble-entrybookkeeping;everyeconomictransactionrecordedasacreditbringsaboutanequalandoffsettingdebitentry,andviceversa.BalanceofPaymentsCategories•Accordingtoaccountingconvention,asourceoffunds(eitheradecreaseinassetsoranincreaseinliabilities)isacredit,andauseoffunds(eitheranincreaseinassetsoradecreaseinliabilitiesornetworth)isadebit.•SupposeaUScompanyexportsmachinetoolstoSwitzerlandatapriceifSFr2M.•AtthecurrentexchangerateSFr1=USD0.75,thisorderisworthUSD1.5M.BalanceofPaymentsCategories•TheSwissimporterpaysfortheorderwithachequedrawnonitsSwissbankaccount.•AcreditisrecordedfortheincreaseinUSexports(areductioninUSgoods–asourceoffunds),andbecausetheexporterhasacquiredaSFrdeposit(anincreaseinaforeignasset–auseoffunds),adebitisrecordedtoreflectaprivatecapitaloutflow:BalanceofPaymentsCategoriesBalanceofPaymentsCategories•SupposetheUScompanydecidestoselltheSFritreceivedtotheFederalReserveforUSD.•Inthiscase,aprivateassetwouldhavebeenconvertedintoanofficial(govt)liability.•Thistransactionwouldshowupasacredittotheprivateassetaccount(asitisasourceoffunds)andadebittotheofficialassetsaccount(asitisauseoffunds):BalanceofPaymentsCategoriesBalanceofPaymentsCategories•Similarly,ifaGermansellsapaintingtoaUSresidentforUSD1MwithpaymentmadebyissuingachequedrawnonaUSbank,adebitisrecordedtoindicateanincreaseinassets(thepainting)byUSresidents,whichisauseoffunds,andacreditisrecordedtoreflectanincreaseinliabilities(paymentforthepainting)toaforeigner,whichisasourceoffunds:BalanceofPaymentsCategoriesBalanceofPaymentsCategories•Inthecaseofunilateraltransfers,whicharegiftsandgrantsoverseas,thetransferisdebitedbecausethedonor’snetworthisreduced,whereasanotheraccountmustbecredited:exports,ifgoodsaredonated;services,ifservicesaredonated;orcapital,iftherecipientreceivescashorcheque.•SupposetheUSRedCrossdonatesUSD100KingoodsforearthquakerelieftoNicaragua.TheBOPentriesforthistransactionwouldappearasfollows:BalanceofPaymentsCategoriesBalanceofPaymentsCategories•Becausedouble-entrybookkeepingensuresthatdebitsequalcredits,thesumofalltransactionsiszero.•Thatis,thesumofthebalanceonthecurrentaccount,thecapitalaccountandthefinancialaccountmustequalzero:0balanceacct-Finbalanceacct-Capitalbalanceacct-CurrentCurrentAccount•Thebalanceonthecurrentaccountreflectsthenetflowofgoods,services,incomeandunilateraltransfers.•Itincludesexportsandimportsofmerchandise(thetradebalance),servicetransactions(invisibles),andincometransfers.•Theserviceaccountincludessalesundermilitarycontracts,tourism,financialcharges(bankingandinsurance),andtransportationexpenses(shippingandairtravel).CurrentAccount•Theincomeaccountincludesinvestmentincome(interestanddividends)andemployeecompensation.•Unilateraltransfersincludepensions,remittances,andothertransfersoverseasforwhichnospecificservicesarerendered.CapitalAccount•Thecapitalaccountrecordscapitaltransfersthatoffsettransactionsthatareundertaken,withoutexchange,infixedassetsorintheirfinancing.•Forexample,migrants’fundsrepresenttheshiftofthemigrants’networthtoorfromtheUS,andareclassifiedascapitaltransfers.•Thisisaminoraccountformostpurposes.FinancialAccount•Financial-accttransactionsaffectanation’swealthandnetcreditorposition.•Thesetransactionsareclassifiedasportfolioinvestment,directinvestment,otherinvestment,orreserveassets.•Portfolioinvestmentsarepurchasesoffinancialassetswithmaturitygreaterthan1yr;short-terminvestmentsinvolvesecuritieswithamaturityoflessthan1yr.FinancialAccount•Directinvestmentsarethos