The Balance of Payments II Capital Account

International Finance
CFVG-May 2009 Professor: M.H. Bouchet
CERAM (c)

Balance of payments Accounting framework and statistical record of all the economic and financial flows that take place over a specified time period between residents of the reporting country and the rest of the world
The time period itself is arbitrary but it is common practice to supply balance of payments data on a monthly, quarterly and yearly basis (IMF) Flows refer to income and expenditure or changes in levels of outstanding assets and liabilities. The accumulation of flows leads to asset or debt stocks.
CERAM (c)

Double bookkeeping: Summary statement that records as a credit (+) any transaction resulting in a receipt from the rest of the world and as a debit (-) any transaction resulting in a payment These transactions lead to changes in supply and demand for foreign exchange, hence an impact on exchange rates, reserve assets and on foreign exchange markets

CERAM (c)

Risk assessment is rooted in balance of payments analysis!

1. 2.

Trade flows and competitiveness Structural or short-term deficits? 3. Exchange rate variations 4. External financing flows 5. Capital flight 6. Debt crisis!
CERAM (c)

US$ billion

US Current account deficit

0 -100 -200 -300 -400 -500 -600 -700 -800

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
US Treasury, IMF
CERAM (c)

-7% PBI

Major net Importers of Capital

Source: IMF 2007

CERAM (c)

Major net Exporters of Capital

Source: IMF 2007

CERAM (c)

* The US CAD dilemma *

2007-08 external deficit= US=760 billion CAD= -6,6% of GDP

Need to shrink the deficit by boosting exports and reducing import growth with a weaker $
BUT need to finance the deficit by attracting US$2,4 billion/day foreign capital inflows with stronger $! Capital sources = surplus countries = Germany + China + Japan + India + Korea Need to maintain positive real interest rates to enhance the dollar attractiveness and competitiveness

Engine of world growth ?

CERAM (c)

The US CAD dilemma revisited (1)

Large US CAD, though:

1.

3.

The US net liabilities have risen less than the cumulative CAD 2. Decline in US net liabilities/GDP Minimal debt servicing burden (the global status of the $ leads to
massive purchases of UST bills, hence low rate of interest)

NYFed staff report n271 12/2006

CERAM (c)

The US CAD dilemma revisited (2)

A dollar depreciation alone will NOT curb the US deficit quickly, because:
1.

2.

3.

Use of the dollar in international trade transactions (all US exports and imports are invoiced in $, hence insensitivity to exchange rate changes): Asia Market share concern of foreign exporters, hence desire to remain competitive in the large US market) High marketing and distribution costs of US imports might insulate the final consumption price of imported goods However, foreign demand for US goods will increase
CERAM (c)

Fed RB NY, June 2007

 Capital

account

Reflects changes in countrys ownership of assets Reflects international market access Financing flows lead to changes in external debt stock, and to future debt servicing payment outflows Financing sources: debt, equity/FDI, international borrowing in the capital markets (Eurobonds, Eurocredits, official financing, ODA, short-term flows)

CERAM (c)

Capital account
The

financial analyst must focus not only on the volume of financing flows to match the financing requirements of the current account deficit, but also the nature of financing sources (private/public) and the sustainability of the financing (short term/long term, volatility, currency mismatch, floating/fixed rates, repayment conditions)

CERAM (c)

The Capital Account

Capital account
+ (-) Direct investment (non debt creating flows) + (-) Portfolio investment (NDCF) + (-) Other long-term capital (private + official) + (-) Other short-term capital (private + official) + (-) Net errors and omissions + (-) Counterpart items + (-) Change in reserves = Capital account balance + Exceptional Financing (or arrears)

From less liquid items to more liquid items!

CERAM (c)

Table of Uses and Sources

SOURCES USES Exports of Goods Imports of Goods Services (shipment, travel) Payments of services Investment Income Official transfers Workers remittances FDI (equity capital) Portfolio Investment Long-term Capital Inflows Long-term Debt Payments Short-term Capital Inflows Short-term Debt Payments Reserve Increase
CERAM (c)

Reserve Decrease

The Capital/Financial Account

The

Capital Account of the balance of payments measures all international economic transactions of financial assets. It is divided into two components:
The Capital Account The Financial Account

The

Capital Account is minor (in magnitude), while the Financial Account is significant.
Source: Eiteman/Pearson
CERAM (c)

The Financial Account

Financial

assets can be classified in a number of different ways including the length of the life of the asset (maturity) and the nature and source of the ownership (public or private). Financial Account, however, uses a third method. This focuses on the degree of investor control over the assets or operations.

The

CERAM (c)

 The

Financial Account consists of three components: Direct Investment in which the investor exerts some explicit degree of control over the assets Portfolio Investment in which the investor has no control over the assets nor any participation in the management Other Investment consists of various shortterm and long-term trade credits, cross-border loans, currency deposits, bank deposits and other capital flows related to cross-border trade
CERAM (c)

Sources of external financing

Official bilateral + multilateral

Private

Paris Club (government to government credits) Export insurance credit agencies (Eximbanks) IFIs RDBs

FDI Portfolio Investment London Club (International bank loans; company-tocompany bank loans) Working capital lines Shortterm Trade credits Bonds & International debt securities

CERAM (c)

Developing countries that have relied less on foreign capital have grown faster! (IMF/03-2007)

CERAM (c)

Where do capital flows go?

CERAM (c)

Who finances whom? Current account balances of OECD (30) and EMCs (160)
700 500 300 100 -100 -300 -500 -700
19 90 19 91 19 92 19 93 19 94 19 19 19 19 19 20 20 20 20 20 20 20 20 20 95 96 97 98 99 00 01 02 03 04 05 06 07 08

US$ billion

EMCs

OECD

Source: IIF, IMF-WEO 2009

CERAM (c)

EMCs shrinking current account surpluses

CERAM (c)

Net external capital sources for EMCs

US$ billion

900 700 500 300 100 -100

private public

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
IIF/IMF
CERAM (c)

Private flows & FDI are a key source of growth financing for EMCs

Source: IIF-2009

CERAM (c)

Net Private Capital Flows to EMCs (Equity, FDI, Portfolio, Banks + non-banks)
1000 900 800 700 600 500 400 300 200 100 0
Billion of US$

Total Asia Lat America Africa

1990

1996

1998

2000

2002

2004

2006

2008

Source: IIF/IMF

CERAM (c)

Net FDI and portfolio capital flows to EMCs

US$ billion

300 250 200 150 100 50 0

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Equity ASIA Latin America

Source: IMF/IIF

CERAM (c)

1. Direct investment and portfolio investment The difference between direct investment and portfolio investment resolves around whether or not the investor intends to take an active role in the management of the enterprise whose assets are being acquired. When the investors purpose is to have an effective voice in the management of the foreign enterprise, it is considered as a direct investment. Examples: Bonds, debentures and the like are portfolio investments in so far as they confer no management or voting rights on their owners (ST and relatively volatile investment) Foreign branches, wholly owned subsidiaries and joint ventures are clearly direct investments (depending on percentage!)

CERAM (c)

What is FDI?

Foreign direct investment = purchase of real assets abroad for the purpose of acquiring a lasting interest in an enterprise and exerting a degree of influence on that enterprises operations. Greenfield investment: new investment in a physical structure in an area where no corporate facilities previously existed (complete ownership and therefore full control over management) Strategic partnerships: formal alliance (joint venture, licensing agreement, distributorship, or agency contract) between two enterprises, with mutual participation in certain activities (advertising, branding, product development, etc.). Mergers and acquisitions: two or more companies decide to pool their assets to form a single new company. Hence, one of the previously existing companies ceases to exist. An acquisition does not necessarily constitute a merger if the preexisting companies continue to exist.
CERAM (c)

FDIs Benefits and challenges

Benefits
Additional

Challenges
Currency

resources available for productive

investment Risk sharing with the rest of the world (equity) Greater external market discipline on macroeconomic policy Greater exploitation of comparative economic advantages Enhanced access to technology, information, ideas and management skills Broader access to export markets through foreign partners Training and broader exposure of national staff Greater liquidity to meet domestic financing needs Broadening and deepening of national capital markets Improvement of financial sector skills

appreciation Reduced scope for independent macroeconomic policy actions Greater exposure to external shocks Demands for protection in local markets Lesser control of foreign owned domestic industry Disruption of national capital markets, asset inflation Risk of rising volatility in financial and exchange markets

CERAM (c)

Source: US GAO 02/2008

CERAM (c)

FDI Flows worldwide

16 14 12 10 8 6 4 2 0
USA UK China/HK France Netherlands Canada Germany Belgium Spain Russia

in % of total volume

France= $81 billion* (7,1% of total)

Source: CNUCED/2007 Total= $1833 billion * IDE In = $81 billion, et IDE Out= $115 billion (OCDE et BDF)
CERAM (c)

Total FDI inflows in US$ trillion

Post-2003 bounceback has been driven by OECD markets. FDI flows to EMCs will remain buoyant in 2007-10, averaging over US$400bn per year, but growth rates will be modest as privatisation tails off and the global economy slows.

CERAM (c)

GLOBAL FDI FLOWS 2008 = $1500 billion

GLOBAL ECONOMY

EMCs

EMCs (35%)

OECD* (65%)

LATIN AMERICA (25%)

ASIA (50%)

PERU (4%) CHILE (10%)

$92 billion
CHINA (36%)

LATIN
AMERICA
MEXICO (15%)

* 30 countries - Mexico
Source: IIF, OECD/UNCTAD CERAM (c)

ASIA

1. 2. 3. 4. 5. 6. 7. 8. 9.

30 most attractive Emerging markets for FDI

10.
11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28.

Economic + Political risk Market potential

AT Kearney GRDI
CERAM (c)

29.
30.

India Russia Vietnam Ukraine China Chile Latvia Slovenia Croacia Turkey Tunisia Thailand Korea Malaysia Macedonia UAE Arabia Saudita Slovakia Mxico Egypt Bulgaria Rumania Hungary Taiwan Bosnia Lituania Brasil Morroco Colombia Kazajstan

TOP 25 Global Confidence Index

AT Kearney 2007

CERAM (c)

Most attractive emerging markets

Lows Risk

High Risk

CERAM (c)

China: FDI Flows

In billions of US$

100 90 80 70 60 50 40 30 20 10 0

Inflows Outflows

Source: OECD

08 20 07 20 06 20 05 20 04 20 03 20 02 20 01 20 00 20 99 19 98 19 97 19 96 19 95 19 94 19 93 19 92 19 91 19 90 19
CERAM (c)

Financial self-sustaining process = high saving rate, stronger banking sector= < dependance on external capital flows

Source: OCDE

CERAM (c)

FDI Flows in Vietnam (BOP source)

In millions of US$, actual disbursed as of 08

7000 6000 5000 4000 3000 2000 1000 0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Source: IMF
CERAM (c)

Jan-April 09: VN attracts US$6,35 billion in registered FDI, down 17% compared to 08, mostly in services.

Overview of FDI in Vietnam

Opening of the Vietnamese economy to FDI in 1987, fast growth of the 1990s, rapid increase in FDI inflows 1988-1996, drop in the 1997-98 Asian crisis, rise since 2004, WTO since 2007.

CERAM (c)

Main sources of FDI in Vietnam

WHO?
USA 2. South Korea 3. Hongkong 60% 4. UK 5. Taiwan 6. Singapore 7. Japan 8. France 9. Netherlands 10. Malaysia
1.
CERAM (c)

WHERE? Sectors
Industry Real estate Oil Mining Tourism

FDI in Vietnam by Sector

CERAM (c)

TOP 10 INVESTOR NATIONS IN VIETNAM

CERAM (c)

Contribution of FDI to Vietnams Economy

FDI

companies contribute 13.3 % to GDP, 23% to export, 25% to state budget revenues. However, FDI attracted into Vietnam is by regional standards still modest FDI-driven employment: 750,000 workers Registered FDI in 2007= $20 billion First 4 months 2008= $7,6 billion ( 42%) and disbursed FDI= $4,1 billion ( 26%) First 4 months 2009: $6,35 billion (down 17%)
CERAM (c)

France: FDI Flows In & Out

200 150 100 50 0 FDI Flows and Outflows in US$ 1975-2007

-50 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005 -100 -150 OUT Ratio OUT/IN= 1,8 -200 IN -250
Source: FMI & OCDE 2008
CERAM (c)

Outsourcing and job losses in Europe

Source: European Fondation for the improvement of living and working conditions/2006
CERAM (c)

Outsourcing and sectoral job losses in Europe

Source: European Restructuring Monitor/2006

CERAM (c)

Offshoring and job losses in Europe

CERAM (c)

2. Other capital is a residual category that groups all the capital transactions that have not been included in direct investment, portfolio investment end reserves.
Two categories:

# Long-term capital # Short-term capital

Non-negotiable

instruments > 1 year or more such as London Club bank loans and mortgages, syndicated credits, euroloans... * Financial assets < 1 year, such as currency, deposits and bills, interbank credit lines, trade credits (Source: BIS)

CERAM (c)

Gross private capital flows to LACs

120000000000

Overall Disbursements from private creditors in US$

100000000000

80000000000

60000000000

40000000000

20000000000

19 70 19 72 19 74 19 76 19 78 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 20 08
CERAM (c)

3. Change in reserves Reserves include:

Hard currency assets + Monetary gold (gold held by the authorities as a financial asset)
Special drawing rights (SDRs): reserves created by IMF as book-keeping entries and credited to the accounts of IMF member countries according to quotas Reserve position in the Fund: (members quota + other claims on the Fund)
CERAM (c)

Foreign Exchange Reserves The largest component of total international liquidity. It includes monetary authorities claims on non-residents in the form of bank deposits, treasury bills, short-term and long-term government securities, and other claims usable in the event of balance of payments need, including nonmarketable claims from inter-central bank and intergovernmental arrangements, without regard as to whether the claim is denominated in the currency of the debtors or the creditors.

+ sign in the BOP means a financing flow in the capital account, i.e., a decrease in the stock of reserves!
CERAM (c)

Vietnams foreign exchange reserves

25000 20000 15000 10000 5000 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
CERAM (c)

Chinas rising official reserve assets

2000 1800 1600 1400 1200 1000 800 600 400 200 0
US$ billion

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
CERAM (c)

4. Counterpart items: offsetting amounts

Counterparts items are analogous to unrequited transfers in the current account. They arise because of the double entry system in balance of payments accounting and refer to adjustments in reserves owing to monetization of gold, allocation or cancellation of SDRs and revaluation of the various components of total reserves. These BOP items do not stem from international transactions.
CERAM (c)

5. Net errors and omissions

Statistical difficulties involved in gathering balance of payments data (and capital flight!). Other sources of E&Os: leads and lags in trade flows, underinvoicing of exports and overinvoicing of imports, undeclared short-term capital movements
CERAM (c)

Net errors and omissions ?

An

examination of the size and direction of NE&Os may shed some light on the accuracy of BoP estimates. The adoption of the double entry accounting system means that the net sum of all credit and debit entries should equal zero. In practice, any discrepancies are recorded in NE&Os, reflecting the net effect of differences in coverage, timing and valuation. An amount > 5% of the gross sum of merchandise exports and imports is a source of concern!
CERAM (c)

20 000

EMCs: Errors and omissions, net

0 2001 -20 000 2002 2003 2004 2005 2006e 2007f

-40 000

-60 000

-80 000
CERAM (c)

In millions of US$ Source: IIF

Vietnams errors & omissions in US$ million

1500 1000 500 0 -500 -1000 -1500 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
CERAM (c)

Russia: Net Errors & Omissions US$ billion

10000 5000 0 -5000 -10000 -15000 -20000 -25000
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
CERAM (c)

Source: IMF-IFS/IIF

Peru and Capital flight

Peruvian non-bank private external deposits in international banks overseas in US$ million
4500 4000 3500 3000 2500 2000 1500 1000 500 0 800 600 400 200 0 -200

Stock Change in flows

-400 -600 -800 -1000

4 19 Q1 77 19 Q2 79 19 Q3 80 19 Q4 81 19 Q1 82 1 Q2 984 19 Q3 85 19 Q4 86 19 Q1 87 19 Q2 89 19 Q3 90 19 Q4 91 19 Q1 92 19 Q2 94 19 Q3 95 19 Q4 96 19 Q1 97 19 Q2 99 20 Q3 00 2 Q4 001 20 Q1 02 20 Q2 04 20 05
CERAM (c)

6. Exceptional Financing
IMF

Drawings World Banks HIPC Initiative London Club debt reduction and restructuring workouts Paris Club debt relief Debt swap transactions

CERAM (c)

IMF Disbursements and Repayments

35000 In SDR million 30000 25000 20000 15000 10000 5000 0
08 20 07 20 06 20 05 20 04 20 03 20 02 20 01 20 00 20 99 19 98 19 97 19 96 19 95 19 94 19 93 19 92 19 91 19 90 19 89 19 88 19 87 19 86 19 85 19 84 19

Credits

Repayments

CERAM (c)

Total IMF Credit Outstanding for all Members

120000 100000 80000 60000 40000 20000 0 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
CERAM (c)

Encours de prts du Fonds Montaire International en millions de dollars

Risk Management and BOP Analysis

Export of goods f.o.b. Imports of goods f.o.b. = Trade balance +/- Exports/Imports of non-financial services + /- Investment income/expenditures (credit/debit) + (-) Private/Official unrequited transfers = Current account balance +/- FDI +/- Portfolio capital Flows + LT Capital Inflows - Debt Servicing Payments +/- ST Capital Flows Reserve Variation
CERAM (c)

+ -

External Finance Analysis: The dual face of Country Risk Liquidity Risk Solvency Risk

Debt Service Ratio: (P+I/X) Interest Ratio (I/X) Current account/GDP Reserve/Import R/M/12 ratio (12 -in months) Elasticity of exports
Growth rate of exports/ Average external interest rate

(ability to pay one's debts)

Debt/Export ratio Debt/GDP ratio Debt/Reserves ST Debt/Reserves

CERAM (c)

Liquidity and Solvency Thresholds

Stock variable Solvency = Debt/GDP < 100% (should always less than 100%) Debt/Exports < 150% (should always less than 150%) Reserves/months of Imports > 6 months Flow variable Liquidity = Debt Service ratio < 33% of X Interest/X ratio < 25%

CERAM (c)

US Payments statistics: the basic balance

Basic

balance = balance on current account and long-term capital It puts below the line changes in reserves and all short-term capital movements (including errors & omissions). It stresses the importance of demand management policies affecting net international transactions in goods and services
CERAM (c)

US International Investment Position

US-owned assets abroad: $6473 US government assets: $244 (official reserves) US private assets: $6229 FDI: $2302 Foreign securities: $1847 Non-bank claims: $891 US Bank claims: $1455

Foreign-owned assets in the US: $9079 Foreign official assets: $1133 FDI: $2007 US Treasury securities: $504 Corporate bonds: $1690 Corporate stocks: $1170 US currency: $297 US bank liabilities: $1407

CERAM (c)

Net US external investment position in US$ billion

500 0 -500 -1000 -1500 -2000 -2500
International assets-International Liabilities
19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 03 20 04 20 05 20 06 20 07 20 08

NEP

-3000
CERAM (c)

Net US external investment position in US$ billion

FRB of NY: Current issues in economics and finance, December 2005, N12:

End-2004: - 2500 billion, or 22% of GDP, but the US earned US$36 billion more on its foreign assets than it paid out to service its foreign liabilities! Despite the surge in net liabilities, investment income has remained positive, largely because US MNCs earn a higher rate of return than do foreign firms operating in the US. The continuing buildup in liabilities, however, will push the US income balance negative, hence boosting the CAD!

CERAM (c)

The History of the U.S. Balance of Payments

Stage I: The U.S. is a young debtor nation (1770-1870) -Current account deficit due to the need to import most goods and inability to produce many goods for export. -Capital account surplus due to a great deal of foreign investment in the U.S. in the areas of roads, farming, cattle ranches, railroads, and canals. Stage II: The U.S. is a mature debtor nation (1870-1920) - Current account deficit due to large investment income being paid back to foreign investors based on the investment of stage I. Merchandise account in surplus -- exports > imports. Stage III: The U.S. is a young creditor nation (1920-1945) -Huge surplus in the current account due to large volume of postwar (WWI) exports. -Capital account in deficit due to a great deal of U.S. investment in Europe for postwar reconstruction.
Source: http://www.digitaleconomist.com/bop_4020.html
CERAM (c)

Stage IV: The U.S. is a mature creditor nation (1945-1980) Merchandise deficit -- exports < imports but an investment income surplus with a slight net surplus overall. -Capital account is in deficit largely due to postwar (WW II) reconstruction in Europe and Japan.

Stage V: (1980- ) -Large (and growing) deficit in the merchandise

accounts (Trade Deficit) and slight surplus in the investment income accounts. -Large surplus in the capital account partially to finance the above merchandise deficit (foreign individuals and banks lending money to individuals in the U.S.) Additionally, since the U.S. has had a low inflation rate since 1982 and consistent economic growth , the U.S. has been a good place to invest relative to the rest of the world. However the current inflow of capital investment could eventually lead to large investment income payments in the near future. The investment income surplus may soon be eroded thus worsening the current account deficit.
CERAM (c)