Priyanka chawla m.

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QUESTIONS 1. Define the balance of payments.

nswer! The balance of payments "#OP$ can be %efine% as the statistical recor% of a co&ntry's international transactions o(er a certain perio% of time presente% in the form of %o&ble)entry bookkeepin*. +. ,hy wo&l% it be &sef&l to e-amine a co&ntry's balance of payments %ata. nswer! It wo&l% be &sef&l to e-amine a co&ntry's #OP for at least two reasons. /irst0 #OP pro(i%es %etaile% information abo&t the s&pply an% %eman% of the co&ntry's c&rrency. Secon%0 #OP %ata can be &se% to e(al&ate the performance of the co&ntry in international economic competition. /or e-ample0 if a co&ntry is e-periencin* perennial #OP %eficits0 it may si*nal that the co&ntry's in%&stries lack competiti(eness. 1. The Unite% States has e-perience% contin&o&s c&rrent acco&nt %eficits since the early 1234s. ,hat %o yo& think are the main ca&ses for the %eficits. ,hat wo&l% be the conse5&ences of contin&o&s U.S. c&rrent acco&nt %eficits. nswer! The c&rrent acco&nt %eficits of U.S. may ha(e reflecte% a few reasons s&ch as "I$ a historically hi*h real interest rate in the U.S.0 which is %&e to balloonin* fe%eral b&%*et %eficits0 that kept the %ollar stron*0 an% "ii$ weak competiti(eness of the U.S. in%&stries. 6. In contrast to the U.S.0 7apan has reali8e% contin&o&s c&rrent acco&nt s&rpl&ses. ,hat co&l% be the main ca&ses for these s&rpl&ses. Is it %esirable to ha(e contin&o&s c&rrent acco&nt s&rpl&ses. nswer! 7apan's contin&o&s c&rrent acco&nt s&rpl&ses may ha(e reflecte% a weak yen an% hi*h competiti(eness of 7apanese in%&stries. 9assi(e capital e-ports by 7apan

Priyanka chawla m.com pre(ente% yen from appreciatin* more than it %i%. t the same time0 forei*ners' e-ports

to 7apan were hampere% by close% nat&re of 7apanese markets. :ontin&o&s c&rrent acco&nt s&rpl&ses %isr&pt free tra%e by promotin* protectionist sentiment in the %eficit co&ntry. It is not %esirable especially when it is bro&*ht abo&t by the mercantilist policies. ;. :omment on the followin* statement! <Since the U.S. imports more than it e-ports0 it is necessary for the U.S. to import capital from forei*n co&ntries to finance its c&rrent acco&nt %eficits.= nswer! The statement pres&pposes that the U.S. c&rrent acco&nt %eficit ca&ses its capital acco&nt s&rpl&s. In reality0 the ca&sality may be r&nnin* in the opposite %irection! U.S. capital acco&nt s&rpl&s may ca&se the co&ntry's c&rrent acco&nt %eficit. S&ppose forei*ners fin% the U.S. a *reat place to in(est an% sen% their capital to the U.S.0 res&ltin* in U.S. capital acco&nt s&rpl&s. This capital inflow will stren*then the %ollar0 h&rtin* the U.S. e-port an% enco&ra*in* imports from forei*n co&ntries0 ca&sin* c&rrent acco&nt %eficits. >. E-plain how a co&ntry can r&n an o(erall balance of payments %eficit or s&rpl&s. nswer! co&ntry can r&n an o(erall #OP %eficit or s&rpl&s by en*a*in* in the official

reser(e transactions. /or e-ample0 an o(erall #OP %eficit can be s&pporte% by %rawin* %own the central bank's reser(e hol%in*s. ?ikewise0 an o(erall #OP s&rpl&s can be absorbe% by a%%in* to the central bank's reser(e hol%in*s. @. E-plain official reser(e assets an% its maAor components. nswer! Official reser(e assets are those financial assets that can be &se% as international means of payments. :&rrently0 official reser(e assets comprise! "I$ *ol%0 "ii$ forei*n e-chan*es0 "iii$ special %rawin* ri*hts "SDBs$0 an% "i($ reser(e positions with the I9/. /orei*n e-chan*es are by far the most important official reser(es.

Priyanka chawla m.com 3. E-plain how to comp&te the o(erall balance an% %isc&ss its si*nificance. nswer! The o(erall #OP is %etermine% by comp&tin* the c&m&lati(e balance of

payments incl&%in* the c&rrent acco&nt0 capital acco&nt0 an% the statistical %iscrepancies. The o(erall #OP is si*nificant beca&se it in%icates a co&ntry's international payment *ap that m&st be finance% by the *o(ernment's official reser(e transactions. 2. Since the early 1234s0 forei*n portfolio in(estors ha(e p&rchase% a si*nificant portion of U.S. treas&ry bon% iss&es. Disc&ss the short)term an% lon*)term effects of forei*ners' portfolio in(estment on the U.S. balance of payments. nswer! s forei*ners p&rchase U.S. Treas&ry bon%s0 U.S. #OP will impro(e in the short r&n.

#&t in the lon* r&n0 U.S. #OP may %eteriorate beca&se the U.S. sho&l% pay interests an% principals to forei*ners. If forei*n f&n%s are &se% pro%&cti(ely an% contrib&tes to the competiti(eness of U.S. in%&stries0 howe(er0 U.S. #OP may impro(e in the lon* r&n. 14. Describe the balance of payments identity an% %isc&ss its implications &n%er the fi-e% an% fle-ible e-chan*e rate re*imes. nswer! The balance of payments i%entity hol%s that the combine% balance on the c&rrent an% capital acco&nts sho&l% be e5&al in si8e0 b&t opposite in si*n0 to the chan*e in the official reser(es! #: C #D E )#B . Un%er the p&re fle-ible e-chan*e rate re*ime0 central banks %o not en*a*e in official reser(e transactions. Th&s0 the o(erall balance m&st balance0 i.e.0 #: E )#D . Un%er the fi-e% e-chan*e rate re*ime0 howe(er0 a co&ntry can ha(e an o(erall #OP s&rpl&s or %eficit as the central bank will accommo%ate it (ia official reser(e transactions. 11. E-hibit 1.1 in%icates that in 12210 the U.S. ha% a c&rrent acco&nt %eficit an% at the same time a capital acco&nt %eficit. E-plain how this can happen. nswer! In 12210 the U.S. e-perience% an o(erall #OP %eficit0 which m&st ha(e been

Priyanka chawla m.com accommo%ate% by the /e%eral Beser(e's official reser(e action0 i.e.0 %rawin* %own its reser(e hol%in*s. 1+. E-plain how each of the followin* transactions will be classifie% an% recor%e% in the %ebit an% cre%it of the U.S. balance of payments! "1$ "+$ "1$ 7apanese ins&rance company p&rchases U.S. Treas&ry bon%s an% pays o&t of its U.S. citi8en cons&mes a meal at a resta&rant in Paris an% pays with her In%ian immi*rant li(in* in ?os merican

bank acco&nt kept in New Fork :ity. E-press car%. n*eles sen%s a check %rawn on his ?. . bank acco&nt as a *ift to his parents li(in* in #ombay. "6$ U.S. comp&ter pro*rammer is hire% by a #ritish company for cons&ltin* an% *ets

pai% from the U.S. bank acco&nt maintaine% by the #ritish company. nswer! GGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGG Transactions :re%it Debit GGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGG 7apanese p&rchase of U.S. T bon%s 7apanese payment &sin* NF: acco&nt

U.S. citi8en ha(in* a meal in Paris Payin* the meal with merican E-press

Hift to parents in #ombay Beceipts of the check by parents "*oo%will$

Priyanka chawla m.com E-port of pro*rammin* ser(ice #ritish payment o&t its acco&nt in U.S.

GGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGGG 11. :onstr&ct the balance of payment table for 7apan for the year of 1223 which is comparable in format to E-hibit 1.10 an% interpret the n&merical %ata. Fo& may cons&lt International /inancial Statistics p&blishe% by I9/ or research for &sef&l websites for the %ata yo&rself. nswer! s&mmary of the 7apanese #alance of Payments for 1223 "in I billion$ :re%its :&rrent cco&nt "1$ E-ports "1.1$ 9erchan%ise "1.+$ Ser(ices "1.1$ /actor income "+$ Imports "+.1$ 9erchan%ise "+.+$ Ser(ices "1.1$ /actor income "1$ Unilateral transfer #alance on c&rrent acco&nt J"1$ C "+$ C "1$K :apital cco&nt "6$ Direct in(estment ";$ Portfolio in(estment ";.1$ E5&ity sec&rities ";.+$ Debt sec&rities ">$ Other in(estment ;.;1 1+4.>2 >6>.41 1@6.46 >+.61 +42.;3 );1>.;4 )+;1.>> )111.31 )1;1.41 )16.1@ Debits

1.+@ @1.@4 1>.11 ;@.;2 12.;1

)+6.>+ )111.@1 )16.44 )22.@1 )142.1; )111.++ )>.1@

#alance on financial acco&nt J"6$ C ";$ C ">$K "@$ Statistical %iscrepancies 6.1> O(erall balance Official Beser(e cco&nt >.1@ So&rce! I9/0 International /inancial Statistics Fearbook0 1222.

Priyanka chawla m.com Note! :apital acco&nt in the abo(e table correspon%s with the L/inancial acco&nt' in I9/'s balance of payment statistics. I9/'s :apital acco&nt' is incl&%e% in LOther in(estment' in the abo(e table.

BALANCE OF PAYMENTS Any transaction resulting in a payment to other countries is entered in the Balance of Payments account as a debit. Any transaction resulting in a receipt from other countries is entered as a credit. Balance of Payments Approach M The #OP approach to forecastin* e-chan*e rates looks at c&rrent acco&nt balances0 portfolio in(estment0 forei*n %irect in(estment0 e-chan*e rate re*imes0 an% official monetary reser(es to %etermine the %irection of the e-chan*e rate. Current Account Balance + Capital Account Balance + Financial Account Balance + eser!e Balance " BOP "N M 9$ C ":I M :O$ C "/I M /O$ C /N# E #alance of Payments N E e-ports of *oo%s an% ser(ices 9 E imports of *oo%s an% ser(ices :I E capital inflows :O E capital o&tflows /I E financial inflows /O E financial o&tflows /N# E official monetary reser(es Note: ,hether or not the co&ntry has a fi-e% e-chan*e rate is an important %eterminate when forecastin* e-chan*e rate mo(ements &sin* the balance of payments approach. Q: Suppose a country has a fixed exchange rate. What are the potential effects on a countrys foreign exchange reser es of a balance of payments deficit! ! deficit in either the basic balance or the official settlements balance will ca&se an initial decrease in the co&ntry's forei*n e-chan*e reser(es ca&se% by increase% fli*ht from the local c&rrency to stron*er forei*n c&rrenciesO if this contin&es the co&ntry will ha(e to de alue its c&rrency. "emember! Un%er a fi#e$ e#chan%e rate system0 the *o(ernment bears the responsibility to ens&re a #OP near #ero. To ens&re a fi-e% e-chan*e rate0 the *o(ernment m&st inter(ene in the forei*n e-chan*e market an% b&y or sell %omestic c&rrencies to brin* the #OP back to near #ero. Th&s0 it is (ery important for a *o(ernment to maintain

Priyanka chawla m.com si*nificant forei*n e-chan*e reser(e balances to allow it to inter(ene in the forei*n e-chan*e market effecti(ely.

Q: Suppose a country has a floating exchange rate. What are the potential effects on a countrys foreign exchange reser es of a balance of payments deficit! ! n acco&nt deficit will ca&se pri(ate parties to A&%*e the economy as bein* weak0 an% the c&rrency will probably %rop in (al&e in the free e-chan*e markets. This %rop mi*ht be self)correctin* beca&se a cheaper local c&rrency will enco&ra*e more e-ports an% make imports more e-pensi(e. No specific reason exists to expect foreign exchange reser es to change. The #alance of Payments acco&nts are %i(i%e% into t$o main sections! 1. The current account M recor%s transactions that pertain to four categories a. &oo$s Tra$e 'Merchan$ise( M the e-port or import of physical *oo%s "a&tos0 comp&ters0 chemicals$ b. Ser!ices Tra$e M intan*ible pro%&cts s&ch as bankin* ser(ice0 ins&rance ser(ices0 an% tra(el ser(ices. c. ')n!estment( )ncome M income from forei*n in(estments an% payments ma%e to forei*n in(estors. %. Current Transfers M financial settlements associate% with the chan*e in ownership of real reso&rces an% financial items s&ch as one)way *ifts or *rants. E-ample! U.S. citi8en owns a share of a /innish company an% recei(es a %i(i%en% of I;0 the payment shows &p on the U.S. balance of payments as a cre$it on the c&rrent acco&nt "in(estment income$. +. The capital*financial account M recor%s transactions that in(ol(e the p&rchase an% sale of assets. There are two main cate*ories. a. :apital cco&nt b. /inancial cco&nt i. +irect )n!estment M 14P or more of the (otin* shares. ii. Portfolio )n!estment M in(estment of less than 14P. iii. Other Asset )n!estment M financial instit&tions0 c&rrency %eposits an% bank %eposits0 an% other acco&nts recei(able an% payable relate% to cross)bor%er tra%e.

Priyanka chawla m.com E-ample! firm in Per& p&rchases stock "less than 14P$ in a U.S. company0 the transaction enters the U.S. balance of payments as a cre$it on the capitalQfinancial acco&nt "portfolio in(estment$. Rere is an a%%itional e-ample! Q. ,hen a Herman cons&mer p&rchases a :ana%ian chain saw0 this transaction is recor%e% as a! . %ebit on the Herman capital acco&nt #. cre%it on the :ana%ian c&rrent acco&nt :. %ebit on the Herman c&rrent acco&nt D. cre%it on the :ana%ian capital acco&nt ,hy. % ery international transaction enters the balance of payments t$ice &once as a credit and once as a debit'. One si%e of the transaction is a %ebit to the Herman current account0 beca&se it has to %o with the import of merchandise. %%itionally0 the other si%e of the transaction will e(ent&ally res&lt in a cre%it to the Herman balance of payments "either the capital or c&rrent acco&nt$ %epen%in* on the action of the :ana%ian company. Since we aren't s&re what the :ana%ian company will %o with the e&ros0 the only si%e of the transaction that is certain an% liste% abo(e is <:= ) %ebit the Herman c&rrent acco&nt.

Facts behind the figures

Sep 18th 2003 From The Economist print edition

A quick guide to the balance of payments

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A country's balance of payments gi es a snapshot of all transactions !ith foreigners" #t has t!o main parts" The current account mainly measures trade in goods and ser ices $%no!n as the trade balance&" #t also includes interest paid on foreign borro!ing $or recei ed on foreign in estments&' as !ell as unilateral transfers abroad' such as official foreign aid and remittances by foreign !or%ers" The second part of the balance of payments is the capital account" #t measures all asset transactions !ith foreigners" The pri ate capital account is made up of pri ate in estments' !hether foreign direct in estment' stoc%s' bonds' or ban% loans" All official transactions $such as the central ban% building up reser es& are dubbed (official reser e transactions)" The sum of the current account' the pri ate capital account' and the official reser e transactions is al!ays *ero" Thus net capital inflo!s' !hether pri ate or official' imply a current+account deficit" ,et capital outflo!s' in contrast' mean the current account !ill be in surplus" -ut !hat do these balances mean in economic terms. A country that runs a currentaccount deficit is spending more than it produces, making up the difference by borrowing from abroad. /ut another !ay' the current account is the difference bet!een ho! much a country sa es and ho! much it in ests" A rising current+ account deficit could imply rising in estment or falling sa ing' or both" To reduce a current+account deficit' a country must sa e more and0or in est less" 1igher sa ing can come from the pri ate sector $companies or households& or from the go ernment through a smaller budget deficit" The current+account balance sho!s the pace at !hich debt is being incurred $or' for a surplus country' the pace at !hich assets are being accumulated&" The basic balance of payments $the current account plus long+term pri ate capital inflo!s& gi es a sense of ho! much a country is borro!ing and ho! !illing pri ate in estors are to fund that borro!ing by pro iding long+term capital"

One last e-ample!

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1. U.S. citi8en p&rchases a r&* from In%ia for I1444. "payment to another co&ntry for *oo%s E %ebit U.S. c&rrent acco&nt$ U.S. C 1 r&* In%ia C I1444

The U.S. has 1 more r&* an% In%ia has an a%%itional I1444. Now the In%ian r&* maker has two options! 1. Deposit the I1444 into a U.S. bank +. :on(ert the I1444 to r&pees Option 1! :re%it U.S. :apital acco&nt Option +!
In%ian bank C I1444 ) - r&pees

Un%er option 10 the U.S. asset "a bank %eposit$ will show &p as a cre%it to the U.S. capital acco&nt. Un%er option +0 the In%ian bank also has options! 1. ?en% the I1444 to a c&stomer for the p&rchase of U.S. *oo%s "e-port of merchan%ise E cre%it U.S. c&rrent acco&nt$ +. P&rchase U.S. *o(ernment bon%s "sale of assets i.e. bon%s E cre%it U.S. capital acco&nt$