International-Financial-Management---Bekaert-2e---Solutions---Ch04.doc

International-Financial-Management---Bekaert-2e---Solutions---Ch04.doc

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Chapter4:

TheBalanceofPayments9

Chapter 4

TheBalanceofPayments

QUESTIONS

1.Whatarethemajoraccountsofthebalanceofpayments,andwhattransactionsarerecordedoneachaccount?

Answer:

Thethreemajoraccountofthebalanceofpaymentsarethecurrentaccount,thecapitalaccount,andtheofficialsettlementsaccount.

Thecurrentaccountrecordsthefollowing:

1.Imports,whicharepurchasesofgoodsandservicesfromforeignresidents,andexports,whicharesalesofgoodsandservicestoforeignresidents.

2.Transactionsassociatedwiththeincomeflowsfromtheownershipofforeignassets（dividendsandinterestpaidtodomesticresidentswhoownforeignassetsaswellasdividendsandinterestpaidtoforeignresidentswhoowndomesticassets）.

3.Unilateraltransfersofmoneybetweencountries（foreignaid,gifts,andgrantsgivenbytheresidentsorgovernmentsofonecountrytothoseofanother）.

Thecapitalaccountrecordsthefollowing:

Purchasesandsalesofforeignassetsbydomesticresidentsaswellasthepurchasesandsalesofdomesticassetsbyforeignresidents.

Thedefinitionofanassetisallinclusive:

Itisanyforminwhichwealthcanbeheld.Itencompassesbothfinancialassets（bankdepositsandloans,corporateandgovernmentbonds,andequities）andrealassets（factories,realestate,antiques,andsoforth）.Hence,thecapitalaccountrecordsallchangesinthedomesticownershipoftheassetsofothernationsaswellaschangesintheforeignownershipoftheassetsofthedomesticcountry.

Theofficialsettlementsaccountrecordsthefollowing:

Transactionsinvolvingthepurchaseorsaleofofficialinternationalreserveassetsbyanation’scentralbank.

Internationalreservesaretheassetsofthecentralbankthatarenotdenominatedinthedomesticcurrency.Goldandassetsdenominatedinforeigncurrencyarethetypicalinternationalreserves.

2.Whyisitimportantforaninternationalmanagertounderstandthebalanceofpayments?

Answer:

Thebalanceofpaymentsprovidesinformationthatisusefulinunderstandingthedeterminationofexchangeratesandthegrowthprospectsofacountry.Forexample,persistent,largecurrentaccountdeficits,especiallyonesthatareprimarilyconsumerdriven,areoftenassociatedwithcurrencycrisesinwhichthecurrencyofthecountrywiththedeficitdepreciatessubstantiallyandthecountrysuffersasevererecession.Knowledgeoftheofficialsettlementsaccountindicateswhetherthecountryisgainingorlosinginternationalreserves,andsufficientlossesofreservesindicatealossoftheabilitytomaintainafixedexchangerate.Massiveincreasesininternationalreservesindicatethatthecentralbankisresistingpressureforthecurrencytoappreciateinvalue.Largecapitalaccountsurplusesthatareprimarilydrivenbyprivatesectorinvestmentsindicatethatforeignersfindtheassetsofthecountrytobeattractiveinvestmentopportunities.

3.Whataretherulesthatdeterminetheresidencyrequirementsonthebalanceofpayments?

Answer:

Therulesforresidencyarethattheentityhasaprimaryeconomicinterestinthecountry.Thus,itisnotcitizenshipthatisbeingmeasured.TheseconceptsarediscussedindetailintheIMF’sBalanceofPaymentsmanualavailableonlineat

http:

//www.imf.org/external/np/sta/bop/BOPman.pdf.

4.Whichitemsonthebalanceofpaymentsarerecordedascredits,andwhichitemsarerecordedasdebits?

Why?

Answer:

Thebalanceofpaymentsusesadouble-entrysystem.Eachtransactiongivesrisetotwoentries:

Oneentryisacredit,andtheotherentryisadebitofequalvalue.AnytransactionresultinginapaymenttoforeignersisenteredintheBOPaccountsasadebit.Anytransactionresultinginareceiptoffundsfromforeignersisenteredasacredit.Inthedoubleentrysystem,theflowofmoneyfromadomesticresidenttoaforeignresidentisacreditandtheitemthatgivesrisetotheflow（eitheranimportofagoodorserviceorthepurchaseofaforeignasset）isadebit.

5.Howaregiftsandgrantshandledinthebalanceofpayments?

Answer:

Giftsandgrantsarehandledasimportsandexportsofgoodwill.Ifadomesticresidentgivesagifttoaforeignresident,thevalueofthegiftisadebit（animportofgoodwill）andthevalueofthegiftisacreditonthedomesticbalanceofpaymentsbecauseitresultsinpaymentoffundstoforeigners.

6.Whatdoesitmeanforacountrytoexperienceacapitalinflow?

Isthisassociatedwithasurplusoradeficitonthecountry’scapitalaccount?

Answer:

Whenacountryexperiencesacapitalinflow,foreignresidentsareinvestingindomesticassetsanddomesticresidentsaresellingforeignassets.Thesetransactionsarecreditsonthebalanceofpaymentsbecausethecountryiseffectivelyexportingassets.Ifcapitalinflowsexceedcapitaloutflows,thereisasurplusonthecountry’scapitalaccount.Thissurpluswouldbeoffsettingacombineddeficitonthecurrentaccountandtheofficialsettlementsaccount.

7.Ifyouaddupallthecurrentaccountsofallcountriesintheworld,thesumshouldbezero.Yetthisisnotso.Why?

Answer:

Thereisalarge,consistentlynegativesignfortheglobalbalanceofpaymentswhichsuggeststhatthediscrepancycannotsimplybeduetomeasurementerrorsbecauseifitwere,thebalancewouldbepositiveaboutasoftenasitisnegative.Onereasonwhythereisaconsistentnegativesignintheaggregateerrorshastodowithtaxevasion.Manyindividualstrytoescapetaxesontheincomefromtheirinvestments.Hence,theymayfailtoreporttheinterestincometheyearnontheirforeignsecurities,whichwouldconstituteacreditfortheirhomecountry’scurrentaccountbalance.Unrecordedearningsintheinternationalshippingbusinessmayalsoaccountforalargepartofthemissingsurplus.Onceagain,thesewouldbecreditsontheserviceaccountofthebalanceofpayments.Countriesthatreceiveforeignaidmayfailtofullyaccountforofficialaiddisbursements.Freertradehasmadeitmoredifficultforgovernmentstomeasuresalesaccurately,andsalesovertheInternetmayalsoescapedetection.

8.Whatistheinvestmentincomeaccountofthebalanceofpayments?

Answer:

Theinvestmentincomeaccountofthebalanceofpaymentsisasub-accountofthecurrentaccount.Itrecordsthedividendandinterestreceiptsthatdomesticresidentsreceiveasincomefromtheirownershipofforeignassets.Theseflowsarecredits.Thedividendandinterestpaymentsthatdomesticresidentsmaketoforeignerswhoowndomesticassetsarerecordedasdebitsontheinvestmentincomeaccount.

9.Whatistheofficialsettlementsaccountofthebalanceofpayments?

Howareofficialsettlementsdeficitsandsurplusesassociatedwithmovementsintheinternationalreservesofthebalanceofpayments?

Answer:

Theofficialsettlementsaccountrecordsthepurchasesandsalesofthecountry’sinternationalreserves.Justasontheprivatesector’scapitalaccount,ifthecentralbankincreasesitsownershipofinternationalreserves,thisisrecordedasadebit,whereasasaleofinternationalreservesisacredit.Thus,iftheofficialsettlementsaccountisinsurplus,thecountryislosinginternationalreserves.

10.Whatisthemeaningofanaccountlabeled“statisticaldiscrepancy”or“errorsandomissions”?

Ifthisaccountisacredit,whatdoesthatimplyaboutthemeasurementofotheritemsinthebalanceofpayments?

Answer:

The“statisticaldiscrepancy”or“errorsandomissions”accountisthevalueofthemeasureditemsonallotheraccountswiththesignreversed.Thus,ifthesumofallotheraccountsisanegativenumber,indicatingthattheotheraccountsareindeficit,thestatisticaldiscrepancymustbeacredit（apositivenumber）.Thestatisticianmissedsomecredititemsontheotheraccounts,becauseweknowthatthesumofallaccountsshouldbezeroduetothedoubleentrynatureofthebalanceofpayments.

11.Whymustthenationalincomeofaclosedeconomyequalthenationalexpendituresofthateconomy?

Whatseparatesthetwoconceptsinanopeneconomy?

Answer:

Inaclosedeconomy,thevalueofthefinalexpendituresonallgoodsandservicesmustbetheincomeofthefactorsofproductionintheeconomy.Inanopeneconomy,finalexpenditurescanfallonforeigngoodsandfactorsofproductioncanearnincomeabroad.Netfactorincomefromabroadplusnetunilateraltransfersfromabroadprovideflowsofresourcesthatseparatetheincomeofthecountryfromthevalueoffinalgoodsandservicesproducedinacountry.

12.Explainwhyprivatenationalsavingplusgovernmentsavingequalsthecurrentaccountofthebalanceofpayments.

Answer:

Savingisthedifferencebetweentheincomeofanentityandwhatthatentityconsumes.Inaclosedeconomy,thevalueofwhatisproduced,thecountry’sgrossdomesticproductorGDP,mustequalitsexpendituresanditsincome.Thus,investmentexpendituresmustbefinancedbynationalsavings.Inthecaseofanopeneconomy,thisdoesnothavetobethecase.Bydefinition,nationalsavingsareequaltonationalincomeminustheconsumptionoftheprivate（C）andpublicsectors（G）:

Nationalsavings=Grossnationalincome–Consumptionoftheprivateandpublicsectors

Symbolically,

S=GNI–C–G

WeknowthatgrossnationalincomeisGDPplusnetforeignincome,so

S=GDP+NFI–C–G

SubstitutingthecomponentsofGDPgives

S=C+I+G+NX+NFI–C–G

Uponcancelingouttheconsumptiontermsandrearrangingterms,wefind

S–I=NX+NFI=CA

Nationalsaving–Nationalinvestment=Currentaccount

Ifacountry’spurchasesofinvestmentgoodsaremorethanitssavings,th