Balance of Payments & Capital Mobility

Question 1

What is the balance of payments?

Answer 1

The measurement of all international economic transactions between the residents of a country and foreign residents is called the balance of payments (BOP)

Question 2

What institution provides the primary source of similar statistics for BoP and economic performance worldwide?

Answer 2

The primary source of similar statistics for balance of payments and economic performance worldwide is the International Monetary Fund, Balance of Payments Statistics

Question 3

Business managers and investors need BOP data to anticipate changes in host country economic policies that might be driven by BOP events. From the perspective of business managers and investors list three specific signals that a country’s BOP data can provide

Answer 3

The BOP is an important indicator of pressure on a country’s foreign exchange rate, and thus on the potential for a firm trading with or investing in that country to experience foreign exchange gains or losses. Changes in the BOP may predict the imposition or removal of foreign exchange controls.

Changes in a country’s BOP may signal the imposition or removal of controls over payment of dividends and interest, license fees, royalty fees, or other cash disbursements to foreign firms or investors.

The BOP helps to forecast a country’s market potential, especially in the short run. A country experiencing a serious trade deficit is not likely to expand imports as it would if running a surplus. It may, however, welcome investments that increase its exports

Question 4

What does it mean to describe the balance of payments as a flow statement?

Answer 4

The BOP is often misunderstood because many people infer from its name that it is a balance sheet, whereas in fact it is a cash flow statement. By recording all international transactions over a period such as a year, the BOP tracks the continuing flows of purchases and payments between a country and all other countries. It does not add up the value of all assets and liabilities of a country on a specific date like a balance sheet does for an individual firm

Question 5

What are the 2 main types of economic activity measured by a country’s BOP?

Answer 5

1. Current transactions having cash flows completed within one year, such as for the import or export of goods and services.
2. Capital and financial transactions, in which investors acquire ownership of a foreign asset, such as a company, or a portfolio investment, such as bonds or shares of common stock

Question 6

Why does the BOP always “balance”?

Answer 6

The algebraic sum of all flows accounted for in the current account and the capital and financial accounts should, in theory, equal changes in a country’s monetary reserves. Because data for the balance of payments is collected on a single-entry basis and some data is missed, the equalization usually does not occur. The imbalance is plugged by an entry called “errors and omissions”, which makes the accounts balance.

Question 7

If the BOP were viewed as an accounting statement, would it be a balance sheet of the country’s wealth, an income statement of the country’s earnings, or a funds flow statement of money into and out of the country?

Answer 7

A country’s balance of payments is similar to a corporation’s funds flow statement in that the
balance of payments records events that cause the receipt (earnings) and disbursement (expenditures) into and out of the country

Question 8

What are the main component accounts for a current account?

Answer 8

1. Trade in goods
2. Trade in services
3. Income payments and receipts
4. Unilateral current transactions

Question 9

What is the difference between credit and debit in the BOP?

Answer 9

Debit: Associated with payment OUTFLOWS (negative signs)
Credit: Associated with payment INFLOWS (positive signs)

Question 10

What is the difference between a real asset and a financial asset?

Answer 10

Real assets are goods (merchandise) and useful services.
Financial assets are financial claims, such as shares of stock or bonds.

Question 11

What is the difference between a direct foreign investment and a portfolio foreign investment?

Answer 11

Direct investment is made with the intent that the investor will have a degree of control over the asset acquired.
EX: building a factory in a foreign country by the subsidiary of a multinational enterprise OR acquiring more than 10% of the voting shares of a foreign corporation.

Portfolio investment is the purchase of less than 10% of the voting shares of a foreign corporation or the purchase of debt instruments.

Question 12

What are the primary sub-components of the financial accounts?

Answer 12

Direct investment
Portfolio investment
Net financial derivatives
Other investments (ie depositing money)

Question 13

What does the balance of goods include?

Answer 13

measures the balance on imports and
exports of merchandise

Question 14

What does the balance on current account include?

Answer 14

expands the balance on goods to include receipts and expenses for services, income flows, and unilateral transfers

Question 15

What is the basic balance in the BOP?

Answer 15

measures all of the international transactions (current, capital, and financial) that come about because of market forces, that is, the balance resulting from all decisions made for private motives - includes gvt expenditures

Question 16

What is the overall balance in the BOP?

Answer 16

total change in a country’s foreign exchange reserves caused by the basic balance plus any governmental action to influence foreign exchange reserves

Question 17

x

Answer 17

x

Question 18

Why is China’s twin surpluses in both the current and financial accounts considered unusual?

Answer 18

Ordinarily, countries experiencing large current account deficits fund these deficits through equally large surpluses in the financial account, and vice versa
China experienced massive current account surplus, paired w sizable financial surplus equally => rare indicator of rapid and exceptional growth
Although size of current acc surplus would normally create large financial deficits, the prospects of the Chinese economy have attracted such a nbr of investors + capital inflow that financial acc is in surplus too

Question 19

The U.S. dollar has maintained or increased its value over the past 20 years despite running a gradually increasing current account deficit. Why has this phenomenon occurred

Answer 19

The U.S. dollar has maintained or increased its value over the past 20 years despite running a gradually increasing current account deficit because the current account deficit has been more than offset by an inflow of dollars on capital and financial account

Question 20

What is the relationship between the BOP and a fixed exchange rate?

Answer 20

Under a fixed exchange rate system, the government is responsible for ensuring that the BOP is near zero.

If the sum of the current and capital accounts does not approximate zero, the government is expected to intervene in the foreign exchange market by buying or selling official foreign exchange reserves.

If the sum of the first two accounts is greater than zero, a surplus demand for the domestic currency exists in the world. To preserve the fixed exchange rate, the government must then intervene in the foreign exchange market and sell domestic currency for foreign currencies or gold in order to bring the BOP back to near zero

Question 21

What is the relationship between the BOP and a floating exchange rate?

Answer 21

Under a floating exchange rate system, the government of a country has no responsibility to peg its foreign exchange rate. The fact that the current and capital account balances do not sum to zero will automatically—in theory—alter the exchange rate in the direction necessary to obtain a BOP near zero.

EX: A country running a sizable current account deficit and a capital and financial accounts balance of zero will have a net BOP deficit. An excess supply of the domestic currency will appear on world markets. Like all goods in excess supply, the market will rid itself of the imbalance by lowering the price. Thus, the domestic currency will fall in value, and the BOP will move back toward zero

Question 22

Describe the evolution of capital mobility over the past 50 years.

Answer 22

The magnitude of capital movements globally has increased dramatically over the past 50 years.
Capital inflows and outflows for major industrial countries now dwarf the transaction values of current account activities. These massive capital movements, if allowed to move without restriction, may cause increasing instability in economies

Question 23

Which do most countries control, capital inflows or capital outflows, and why?

Answer 23

Most countries are slow and careful to deregulate capital inflows, allowing them more control over what kinds of capital enter the country over what periods of time. If regulated on entry, they are typically easier to regulate than exit. Massive capital inflows are often considered potentially more disruptive if not managed correctly.

Question 24

How does capital mobility typically differ between industrialised countries and emerging market countries?

Answer 24

Emerging market countries, by definition, have relatively small and undeveloped financial systems and sectors. Outside of some potential foreign direct investment opportunities, they offer few choices for capital to flow in of substance.

Industrialized countries, however, typically have large and sophisticated financial sectors that offer a multitude of financial investment options and assets, which on occasion may attract large capital inflows or suffer large capital outflows.

Question 25

What is the formula for balance of payments?

Answer 25

BOP = (X-M) + (CI-CO) + (FI-FO) + FXB

Current acc + capital acc + financial acc + reserve balance

Question 26

What is capital mobility?

Answer 26

Degree of freedom w which capital moves across borders = essential for country’s BOP

Question 27

What is capital control?

Answer 27

any restriction that limits/alters the rate or direction of capital movement into or out of a country

Question 28

What is capital flight?

Answer 28

rapid outflow of capital in fear of domestic political and economic conditions and policies

Question 29

How can capital be moved?

Answer 29

Capital can be moved via international transfers, with physical currency, collectables or precious metals, money laundering or false invoicing of international trade transactions