1. Lecture 3

2. BOP
The BOP is a
statistical record of
the flow of all of the
payments between
the residents of a
country and the rest
of the world in a
given year.

3. Current Account (CA)
 This is record of a country’s trade in goods and
services in the current period.
CA = Exports (X) – Imports (M)
 It is divided into 4 sub-categories:
 Goods trade
 Services trade
 Income
 Current transfers
 The sum of the four sub-categories = CA balance
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4. Capital Account (KA)
 This includes all short- and long-term transactions
pertaining to financial assets.
KA = Capital Inflow (cr) – Capital outflow (dr)
 The two main components:
 Capital account.
 Financial account (direct, portfolio, other).
 KA balance = Sum of capital account and financial
account.
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5. Official Reserves
 Records the purchase or sale of official reserve assets by
the central bank. These assets include
 Commercial paper, Treasury bills and bonds
 Foreign currency
 Money deposited with the IMF
 This account shows the change in foreign exchange
reserves held by the central bank.
The Balance of
 Since the BOP must balance Payments Identity
CA + KA + RFX = 0
 CA + KA = – RFX
 For floating rate regime countries, such as the
U.S., official reserves are relatively unimportant.
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6. Accounting Principles
1. Any transaction resulting in a payment to foreigners is
entered in the BOP accounts as a debit and is given a
negative sign.
2. Any transaction resulting in a receipt from foreigners is
entered as a credit and given a positive sign.
3. Current Account records transactions involving exports
and imports of goods and services
4. Capital Account records transactions involving the
purchase and sale of assets.
5. Double-Entry book keeping: Every international
transaction automatically enters twice, once as a credit
and once as a debit.
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7. Examples of Transactions
 An Australian company exports goods worth US$1 million
to the United States:
 Export of goods is credit for the current account.
 Increase in foreign asset (US$1 million) is debit for capital
account.
 Australian company then coverts US$ into A$ and buys
government bonds back in Australia:
 Decrease in foreign asset is credit for the capital account.
 Increase in government liability is debit for official reserves
account.
 Australian individual imports a sports car from Europe:
 Increase in foreign liabilities is credit for the capital account.
 Import of goods is debit for current account.
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8. BOP & Exchange Rates
(X – M) + (CI – CO) + (FI – FO) + FXB = BOP
Where:
X = exports of goods and services
Current
M = imports of goods and services Account
CI = capital inflows Capital
Balance
CO = capital outflows Account
FI = financial inflows Balance
Financial
FO = financial outflows Account Balance
FXB = official monetary reserves
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9. Deficit and Surplus --BOP
 Sub divided into components accounts
 (Credit- debit ) net balance is positive --- BOP Surplus
“ “ Negative --- BOP Deficit
Transaction--- 2 types
1. Autonomous
2. Accommodating/ Compensatory
Trade Balance
Balance on goods and services(exclude pvt. investment
income)
Current account balance
Balance on CA and long term KA

10. BOP & Macroeconomic Variables
A nation’s balance of payments interacts with
nearly all of its key macroeconomic variables.
Interacts means that the BOP affects and is affected
by such key macroeconomic factors as:
 Gross Domestic Product (GDP)
 Exchange rate
 Interest rates
 Inflation rates
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