C H A P T e R 02r

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C H A P T E R 2
International Flow of Funds
2
Chapter Overview
A. Balance of Payments
B. International Trade Flows
C. International Trade Issues
D. Factors Affecting International Trade
Flows
E. Correcting a Balance of Trade Deficit
F. International Capital Flows
G. Agencies That Facilitate International
Flows
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Chapter 2 Objectives
This chapter will:
A. Explain the key components of the
balance of payment
B. Explain how international trade
flows are influenced by economic
factors and other factors
C. Explain how international capital
flows are influenced by country
characteristics
Copyright 2004 Pearson
Addison-Wesley. All rights
reserved.
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International business transactions
occur in many different forms over
the course of a year.
The measurement of all international
economic transactions between the
residents of a country and foreign
residents is called the balance of
payments (BOP).
reserved.
3-5
BOP data is important for government
policymakers and MNEs as it is a gauge of a
nations competitiveness or health (domestic
and/or foreign).
For a MNE both home and host country BOP data
is important as:
An indication of pressure on a countrys foreign
exchange rate
A signal of the imposition or removal of
controls in various sorts of payments
(dividends, interest, license fees, royalties and
other cash disbursements)
A forecast of a countrys market potential
(especially in the short run)
Balance of Payments
Current Account
-The summary of the flow of funds
between one specified country and
other countries due to the purchase
of goods or services, or the
provision of income on financial
asset.
-Main components: Payments for;
a) Goods and services
b) Factor income
c) Transfers
Capital & Financial
Account
-The summary of the flow of
funds from the sale of assets
between one specified country
and other countries over a
specified period of time
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Double-entry book keeping:

Currency inflows = credit
(earn foreign exchange)

Currency outflows = debit
(expend foreign exchange)

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1. Current Account:
a. Payments for merchandise and
services (trade)
- Imports and exports such as
clothings, cars, tourism etc.
- the difference between total
exports and imports is referred
to as the balance of trade

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1. Current Account:
b. Factor Income Payments
- Income received by investors
on foreign investments in
financial assets (i.e. interest
and dividend payments).
c. Transfer Payments
- Aids, grants, and gifts from
one country to another.

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Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total
2009 9.1 12.2 13 7.4 10 9.1 7.8 9.6 9.3 11.5 8.9 107.8
2008 9.7 9.1 8 12.3 15.5 12.9 14.4 12.6 14.7 9.6 11.5 11.5 141.9
2007 7.6 6.9 6.5 5.9 8 8.8 8 8.8 11.5 8.6 10.4 9.4 100.3
2006 9 7.7 9.9 7.2 8.3 8.5 9.4 10.3 10.6 9.7 9.3 11.1 111.1
Balance of Trade: Malaysia
Source: Dept of Statistics Malaysia
reserved.
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2.The Capital Account of the balance
of payments measures all
international economic transactions
of financial assets. It is divided into
two major components:
The Capital Account
The Financial Account
The Capital Account is minor (in
magnitude), while the Financial
Account is significant.
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2. Capital and Financial Accounts
- The capital account includes the value
of financial assets transferred across
country borders by people who move to
different country.
- It also includes the value of nonproduced
nonfinancial assets that are transferred
across country borders, such as patents
and trademarks.

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2. Capital and Financial Accounts
- The financial account includes payments for:
a) Direct foreign investment
- Investment in fixed assets in foreign countries that can be
used to conduct business operations.
b) Portfolio Investment
- Transactions involving long-term financial assets (such as
stocks and bonds) between countries that do not affect the
transfer of control.
c) Other capital investment
- Transactions involving short-term financial assets (such
as money market securities) between countries.
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2. Capital and Financial Account
d. Errors and Omissions and Reserves
- A negative balance on the current
account should be offset by a positive
balance on the capital and financial account
- Reserves are the foreign currency and
securities held by the government, usually
by its central bank, and is used to balance
the payments from year to year.

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A. Balance of Payments Ex.
In 2003, the United States exported $714 billion of
merchandise and imported $1,263 billion, for a merchandise
trade deficit of $549 billion. However, service exports were
$305 billion and service imports were $246 billion, for a
surplus of approximately $59 billion. The trade deficit on
goods and services, therefore, was $490 billion. U.S. interest
payments to other countries and U.S. interest income from
abroad were $250 and $272, respectively, and there was a
net outflow of $68 billion in unilateral transfers. Therefore,
the current account showed an overall deficit of $536 billion.
Capital account transactions yielded a net outflow of $3.1
billion. For the financial account, U.S. investors acquired
$277 billion of assets abroad and foreign investors acquired
$857 billion of assets in the United States, yielding a net
financial and capital account surplus of $580 billion. That
surplus, minus a statistical discrepancy of $40.9 billion,
balanced the $536-billion current account deficit.

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1. Distribution of Malaysian Exports
and Imports

Major Export Jan-Dec January - November
(RM Million) 2008
p
2008
p
2009
Natural Rubber 8,111 7,810 3,892
Palm Oil & Palm Oil-Based Products 64,987 60,409 46,209
Crude Petroleum 43,198 41,506 22,148
Petroleum Products 28,986 27,431 17,390
Liqufied Natural Gas 40,732 35,550 27,888
Timber & Timber Based Products 22,552 20,697 17,571
Electrical & Electronic Products 255,360 238,348 205,099
Articles of Apparel & Clothing
Accessories 12,096 11,055 10,002
Other Manufactured Goods and Articles 86,078 80,135 69,085
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and Imports

The values of major import products :-
Machinery and transport equipment
(RM118.5 billion or 51.0% of total imports);
Manufactured goods and articles (RM28.9
billion or 12.4% of total imports);
Chemicals (RM21.3 billion or 9.2% of total
imports);
Mineral fuels, lubricants, etc., (RM17.5
billion or 7.5% of total imports); and
Food (RM15.4 billion or 6.6% of total
imports).
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and Imports

Malaysias top ten exports destinations were the
Republic of Singapore, the United States of
America, the Peoples Republic of China, Japan,
Thailand, Hong Kong, the Republic of Korea,
Australia, India and the Republic of Indonesia.
These countries accounted for RM212.8 billion or
71.1% of Malaysias total exports in the period of
January - July 2009.

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and Imports

The top ten import sources of Malaysia were the
Peoples Republic of China, Japan, the United
States of America, the Republic of Singapore,
Thailand, the Republic of Indonesia, the Republic
of Korea, the Federal Republic of Germany,
Taiwan and Hong Kong. The total imports from
these countries amounted to RM174.6 billion or
75.2% of Malaysias total imports in the first
seven month of 2009.

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and Imports

Malaysias top ten trading partners were the
Republic of Singapore, the Peoples Republic of
China, the United States of America, Japan,
Thailand, the Republic of Korea, the Republic of
Indonesia, Hong Kong, the Federal Republic of
Germany and Taiwan. These countries collectively
contributed 71.8% (RM381.6 billion) of Malaysias
total trade in the period of January July 2009.

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2. Malaysian Balance of Trade (BOT)
Trend

1. In July 2009, Malaysias exports grew 8.4% that registered
total value of RM48.9 billion, while the imports were RM41. 1
billion, an increase of 14.2% as compared with June 2009.
However, Malaysias exports decreased by 22.8% from RM63.3
billion and imports also declined by 16.0% from RM48.9 billion,
year on year basis.

2. In July 2009, total trade recorded a positive growth of 11.0%
or 8.9 billion, month on month basis. Total trade was valued at
RM89.9 billion, a decrease of 19.9% from a year ago.

3. A trade surplus of RM7.8 billion was recorded in July 2009, a
decrease of 45.8% as compared with RM14.4 billion registered
in the same month of 2008. This was the 141th consecutive
month of trade surplus since November 1997.

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Trend

4. Electrical & electronic products retained its position as the
main exports revenue earner, accounting for RM20.6 billion or
42.2% of total exports, recorded an increase of RM2.0 billion or
10.8% as compared with the previous month. However, for year
on year basis, electrical & electronic products registered a
decrease of RM3.8 billion (-15.6%).

5. Palm oil & palm oil-based products (9.6% of total exports),
followed as the second largest exports revenue earner with a
total combined value of RM4.7 billion in July 2009. It posted an
increase of 2.6%, month on month.In contrast, it registered a
decrease of 31.7%, year on year.
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Trend

6.The third largest exports commodity, Liquefied natural
gas (LNG) amounted to RM2.0 billion or 4.1% of total
exports. Total exports of LNG went up by 11.5%, month
on month, but dipped by 31.6% as against with July
2008.

7. Imports of intermediate goods, constituted 68.7% of
total imports, posted an increase of 11.3% to RM28.2
billion, month on month. Conversely, it registered a
decrease of 20.6% from RM35.6 billion as compared with
the same month of 2008.

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3. Should we be concerned about a
huge BOT Deficit?
- If everyone from Malaysia purchase all their
products from Malaysian firms, this would be
advantageous for the Malaysian firms.
- International trade caused a shift of production to
countries that can produce more efficiently. This
forces products prices low.
- What about advanced countries where factors of
production is high?

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1. Events that Increased International
Trade
a. Removal of the Berlin Wall -1989
b. Single European Act -1980s
c. NAFTA -1993
d. Inception of the Euro -1999
e. European Union Expansion - 2004
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2. Trade Friction:
- Even though trade treaties have reduced
tariffs and quotas over time, most
countries still impose some type of trade
restrictions on particular products in order
to protect their local firms.

- Proton?
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2. Trade Friction:
- Certain countries are not strict on
environmental issues, child labour,
corruption, and subsidies.

- Tax breaks for certain industries.
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2. Trade Friction: Causes
a. Using the exchange rate as
policy (i.e. strong Euro and
Yuan)
b. Outsourcing (i.e. job losses)
c. Using trade and foreign ownership
policies for security (i.e. military)
d. Using trade policies for political
reasons (i.e. sanctions/punishment)
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D. Factors Affecting International
Trade Flows

a. Inflation (Interest Rates)
- If a countrys inflation rate increases relative to
the countries which it trades, its current account
will be expected to decrease, cet. par.
- Consumers and corporations in that country will
most likely purchase more goods overseas (due
to high local inflation)
- The countrys export is expected to decline.

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Trade Flows

b. National Income
- If a countrys income level (national income)
increases by a higher % than those of other
countries, its current account is expected to
decrease, cet. par.
- Consumption of goods will increase according
to real income level.
- Increase demand for foreign goods.
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Trade Flows

c. Government Policies (Tax Rates
on Interest or Dividends)
- Subsidies for Exporters.
- Restrictions on Imports (i.e. tariffs and quota).
- Lack of Restrictions on Piracy (piracy imports ).

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Trade Flows

d. Exchange Rates
- If a countrys currency begins to rise in value
against other currencies, cet. par., its current
account balance should decrease.
- Currency balance-of-trade deficit
- Currency balance-of-trade deficit
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E. Correcting a Balance of Trade
(BOT) Deficit
- A country can benefit from BOT deficit
via cheaper imported products

- This leads to reliance on foreign
production (Job goes overseas).

- Government might have to interfere to
correct BOT deficit.
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(BOT) Deficit
- Any policy that will increase foreign demand
for the countrys goods & services will improve
its BOT position.

- Floating exchange rate?

- Because the country is selling its currency (to
buy foreign goods) in greater volume than the
foreign demand for its currency, the value of
its currency should decrease.

- BUT NOT ALWAYS NECESSARILY!
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(BOT) Deficit
1. Why a Weak Home Currency is Not
a Perfect Solution

a. Counterpricing by Competitors

b. Impact of Other Weak Currencies
(currencies dont always move together)

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(BOT) Deficit
a Perfect Solution

c. Prearranged International
Transactions: J-curve Effect
- International business transactions a
prearranged transactions that cannot be
immediately adjusted.

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Insert exhibit 2.6 page 38
J-Curve Effect
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(BOT) Deficit
a Perfect Solution

d. Intercompany Trade
- Importers and exporters that are under the
same ownership have unique relationship.

- The impact of exchange rate movements on
intracompany trade patterns is limited.
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1. Distribution of DFI by U.S. Firms
- Europe 50%
- Latin America 30%
- Asia & Pacific Region 16%

2. Distribution of DFI in the United States
- UK, Japan, The Netherlands, Germany
and Canada.
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3. Factors Affecting DFI
a. Changes in Restrictions
b. Privatization
c. Potential Economic Growth
d. Tax Rates
e. Exchange Rates
- Invest when the host countrys currency is
weak and reap the benefits when the
currency is stronger.
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Factors Affecting International Portfolio
Investment

a. Tax Rates on Interest or Dividends
b. Interest Rates
- Money tends to flow to countries with high
interest rates as long as the local currency
are not expected to weaken.
c. Exchange Rates

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Insert exhibit 2.7 page 39
International Capital Flows (quarterly numbers, annualized; in billions of $)
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4. Impact of International Capital
Flows

Impact of the international Flow of Funds on U.S. Interest Rates and
Business Investment in the United States
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G. Agencies that Facilitate
International Flows
1. International Monetary Funds
- The International Monetary Fund (IMF) is an
organization of 186 countries, working to foster
global monetary cooperation, secure financial
stability, facilitate international trade, promote
high employment and sustainable economic
growth, and reduce poverty around the world.
2. World Bank
- Provide loans to countries to enhance economic
development (fight poverty).
- Cofinancing (Development agencies, export
credit agencies, and commercial banks)

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International Flows
3. World Trade Organization
- Forum for multilateral trade negotiations and to
settle trade disputes related to GATT accord.
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International Flows
4. International Financial Corporation
- Promote private enterprise within countries.
- It not only provide loans but also purchases
stocks.

5. International Development Association
- Similar to the World Bank

6. Bank for International Settlements
- Facilitate cooperation among countries with
regard to international transactions.
- Also provides assistance to countries experiencing
financial crisis.

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International Flows
7. Organization for Economic
Cooperation and Development (OECD)
- Facilitates governance in governments and
corporations of countries with market economics.
- Promotes international country relationship that
lead to globalization.

8. Regional Development Agencies
- Asian development Bank, African Development
Bank, European Bank of Reconstruction and
Development.

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