Introduction

Ministry of Education and Science of Ukraine

State Education Institution

Pridneprovsk State Academy of Building and Architecture

Finance and marketing department

TERM PAPER

On «Finance»

Variant № 12

«Balance of payment»

Prepared by:

Student 587 group

Lastovina A.R.

Checked by:

Galushko O.I.

Mark:

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Dnipropetrovs’k

Contents

Introduction

General concept of Balance of Payments

Essence of Balance of Payments

Imbalances

Conclusion

Bibliography

Introduction

In a world of increasing globalization, where political, economic and technological barriers are rapidly disappearing, the ability of a country to participate in global activity is an important indicator of its performance and competitiveness.

In order to remain competitive, modern day business relationships extend well beyond the traditional foreign exchange of goods and services, as witnessed by the increasing reliance of firms on mergers, partnerships, joint ventures, licensing agreements, and other forms of business cooperation. External trade may be complemented or substituted by producing (and often selling) goods and services in countries other than where an enterprise was first established: this approach is known as foreign direct investment (FDI), whereby the enterprise concerned either invests to establish a new plant/office, or alternatively, purchases existing assets of a foreign enterprise. FDI is a type of international investment where an entity that is resident in one economy (the direct investor) acquires a lasting interest (at least 10 % of the voting power) in an enterprise operating in another economy.

Conventional trade is less important for services than for goods and while trade in services has been growing, the share of services in total intra-EU trade has changed little during the last decade. However, FDI is expanding more rapidly for services than for goods, as FDI in services has increased at a more rapid pace than conventional trade in services. As a result, the share of services in total FDI flows and positions has increased substantially, with European services becoming increasingly international.

The balance of payments is a statistical statement that summarizes the transactions of an economy with the rest of the world. Transactions are organized in two different accounts, the current account and the capital and financial account, whose sum, in principle, should be zero, as for each credit transaction there is a corresponding one on the debit side. Thus, the current account balance determines the exposure of an economy vis-à-vis the rest of the world, whereas the capital and financial account explains how it is financed.

The balance of payments is also a statistical summary of international transactions. These transactions are defined as the transfer of ownership of something that has an economic value measurable in monetary terms from residents of one country to residents of another. The transfer may involve:

(1) goods, which consist of tangible and visible commodities or products,

(2) services, which consist of intangible commodities that are produced, transferred, and consumed at the same time,

(3) income (which is sometimes classified in “services”),

(4) financial claims on, and liabilities to, the rest of the world, including changes in a country’s reserve assets held by the central monetary authorities. Generally, a transaction is the exchange of one asset for another—or one asset for several assets— but it may also involve a gift, which is the provision by one party of something of economic value to another party without something of economic value being received in return.

International transactions are recorded in the balance of payments on the basis of the double-entry principle used in business accounting, in which each transaction

gives rise to two offsetting entries of equal value so that, in principle, the resulting credit and debit entries always balance. Transactions are generally valued at market prices and are, to the extent possible, recorded when a change of ownership occurs. Transactions in goods, services, and unilateral transfers constitute the current account, and transactions in financial assets and liabilities constitute the capital account.

The International Monetary Fund, which strives for international comparability, defines the balance of payments as “a statistical statement for a given period showing:

(1) transactions in goods, services, and income between an economy and the rest of the world,

(2) changes of ownership and other changes in that economy’s monetary gold, special drawing rights (SDR’s), and claims on and liabilities to the rest of the world,

(3) unrequited transfers and counterpart entries that are needed to balance, in the accounting sense, any entries for the foregoing transactions and changes which are not mutually offsetting”.

I. General concept of Balance of Payments

‘Balance of Payments’ is a term that is used to refer to an accounting record for all the monetary transactions conducted by a country with other countries within a specified period of time. Usually one year. Balance of Payments is actually a numerical summary of all international transactions, and is preferably presented in the country’s domestic currency. In a balance of payments document, exports are recorded as positive items, due to the fact that they earn revenue for the government. Imports and other expenditures are recorded as negative items. The balance between these two is very important, and is perhaps the reason why such a transaction is referred to a balance of payment. In a balance of payments, all the items need to measure up to each other, that is, they should all add up to zero in order for there to be a perfect balance. Even if the country is in a deficit situation, where it is spending more than what it is earning, this deficit ought to be countered by returns from investments, utilizing of reserves, or borrowing of loans either from other sovereign nations or from international financial institutions. In essence a balance of payments is an accounting statement, much like a balance sheet, and should be perfectly balanced for it to qualify as such.

Balance of payments (BoP) accounts are an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers. The BoP accounts summarize international transactions for a specific period, usually a year, and are prepared in a single currency, typically the domestic currency for the country concerned. Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items.

When all components of the BOP accounts are included they must sum to zero with no overall surplus or deficit. For example, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counterbalanced in other ways – such as by funds earned from its foreign investments, by running down central bank reserves or by receiving loans from other countries.

While the overall BOP accounts will always balance when all types of payments are included, imbalances are possible on individual elements of the BOP, such as the current account, the capital account excluding the central bank's reserve account, or the sum of the two. Imbalances in the latter sum can result in surplus countries accumulating wealth, while deficit nations become increasingly indebted. The term "balance of payments" often refers to this sum: a country's balance of payments is said to be in surplus (equivalently, the balance of payments is positive) by a certain amount if sources of funds (such as export goods sold and bonds sold) exceed uses of funds (such as paying for imported goods and paying for foreign bonds purchased) by that amount. There is said to be a balance of payments deficit (the balance of payments is said to be negative) if the former are less than the latter.

Under a fixed exchange rate system, the central bank accommodates those flows by buying up any net inflow of funds into the country or by providing foreign currency funds to the foreign exchange market to match any international outflow of funds, thus preventing the funds flows from affecting the exchange rate between the country's currency and other currencies. Then the net change per year in the central bank's foreign exchange reserves is sometimes called the balance of payments surplus or deficit. Alternatives to a fixed exchange rate system include a managed float where some changes of exchange rates are allowed, or at the other extreme a purely floating exchange rate (also known as a purely flexible exchange rate). With a pure float the central bank does not intervene at all to protect or devalue its currency, allowing the rate to be set by the market, and the central bank's foreign exchange reserves do not change.

Historically there have been different pedagolocigal approaches to the question of how or even whether to eliminate current account or trade imbalances. With record trade imbalances held up as one of the contributing factors to the financial crisis of 2007–2010, plans to address global imbalances have been high on the agenda of policy makers since 2009.

The Balance of Payments Divided
The BOP is divided into three main categories: the current account, the capital account and the financial account. Within these three categories are sub-divisions, each of which accounts for a different type of international monetary transaction.
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.
Within the current account are credits and debits on the trade of merchandise, which includes goods such as raw materials and manufactured goods that are bought, sold or given away (possibly in the form of aid). Services refer to receipts from tourism, transportation (like the levy that must be paid in Egypt when a ship passes through the Suez Canal), engineering, business service fees (from lawyers or management consulting, for example), and royalties from patents and copyrights. When combined, goods and services together make up a country's balance of trade (BOT). The BOT is typically the biggest bulk of a country's balance of payments as it makes up total imports and exports. If a country has a balance of trade deficit, it imports more than it exports, and if it has a balance of trade surplus, it exports more than it imports.
Receipts from income-generating assets such as stocks (in the form of dividends) are also recorded in the current account. The last component of the current account is unilateral transfers. These are credits that are mostly worker's remittances, which are salaries sent back into the home country of a national working abroad, as well as foreign aid that is directly received.
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 (for example, a physical asset such as land) 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 (assets such as equipment used in the production process to generate income), 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.

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 (SDRs) held with the International Monetary Fund, private assets held abroad, and direct foreign investment. Assets owned by foreigners, private and official, are also recorded in the financial account.
The Balancing Act
The current account should be balanced against the combined-capital and financial accounts. However, as mentioned above, this rarely happens. We should also note that, with fluctuating exchange rates , the change in the value of money can add to BOP discrepancies. When there is a deficit in the current account, which is a balance of trade deficit, the difference can be borrowed or funded by the capital account. If a country has a fixed asset abroad, this borrowed amount is marked as a capital account outflow. However, the sale of that fixed asset would be considered a current account inflow (earnings from investments). The current account deficit would thus be funded.
When a country has a current account deficit that is financed by the capital account, the country is actually foregoing capital assets for more goods and services. If a country is borrowing money to fund its current account deficit, this would appear as an inflow of foreign capital in the BOP.
Liberalizing the Accounts
The rise of global financial transactions and trade in the late-20th century spurred BOP and macroeconomic liberalization in many developing nations. With the advent of the emerging market economic boom - in which capital flows into these markets tripled from USD 50 million to USD 150 million from the late 1980s until the Asian crisis - developing countries were urged to lift restrictions on capital and financial-account transactions in order to take advantage of these capital inflows. Many of these countries had restrictive macroeconomic policies, by which regulations prevented foreign ownership of financial and non-financial assets. The regulations also limited the transfer of funds abroad. But with capital and financial account liberalization, capital markets began to grow, not only allowing a more transparent and sophisticated market for investors, but also giving rise to foreign direct investment. For example, investments in the form of a new power station would bring a country greater exposure to new technologies and efficiency , eventually increasing the nation's overall gross domestic product by allowing for greater volumes of production. Liberalization can also facilitate less risk by allowing greater diversification in various markets.

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