Chapter 4

The Balance
of Payments
 The Balance of Payments:
Learning Objectives

• Learn how nations measure their own levels of

international economic activity, and how that is
measured by the balance of payments
• Examine the economic relationships underlying the
two basic sub-components of the balance of
payments – the Current and Capital Accounts
• Consider the financial dimensions of international
economic activity, and how they differ between
merchandise & services trade

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 The Balance of Payments

• Identify balance of payment activities by nations

in pursuit of macroeconomic policies
• Examine how exchange rate changes and volatility
influence trade balances over time

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 The Balance of Payments

• The measurement of all international economic

transactions between the residents of a country
and foreign residents is called the Balance of
Payments (BOP)
– The IMF is the primary source of similar statistics
worldwide
– Multinational businesses use various BOP measures to
gauge the growth and health of specific types of trade or
financial transactions by country and regions of the world
against the home country

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 The Balance of Payments

– Monetary and fiscal policy must take the BOP into

account at the national level
– Businesses need BOP data to anticipate changes in host
country’s economic policies driven by BOP events
– BOP data may be important for the following reasons
• BOP is important indicator of pressure on a country’s
exchange rate, thus potential to either gain or lose if firm is
trading with that country or currency
• Changes in a country’s BOP may signal imposition (or
removal) of controls over payments, dividends, interest, etc
• BOP helps to forecast a country’s market potential,
especially in the short run

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 Typical BOP Transactions

• Examples of BOP transactions from US perspective

– Honda US is the distributor of cars manufactured in Japan by its
parent, Honda of Japan
– US based firm, Fluor Corp., manages the construction of a
major water treatment facility in Bangkok, Thailand
– US subsidiary of French firm, Saint Gobain, pays profits
(dividends) back to parent firm in Paris
– An American tourist purchases a small Lapponia necklace in
Finland
– A Mexican lawyer purchases a US corporate bond through an
investment broker in Cleveland
• A rule of thumb that aids in understanding the BOP is to
“follow the cash flow”

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 Exhibit 4.1 Generic Balance of
Payments

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 Fundamentals of BOP Accounting

• Three main elements of actual process of

measuring international economic activity
– Identifying what is/is not an international
economic transaction
– Understanding how the flow of goods, services,
assets, money create debits and credits
– Understanding the bookkeeping procedures for
BOP accounting
• The BOP must balance

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 Defining International Economic
Transactions

• Current Account Transactions

– The export of merchandise, goods such as trucks,
machinery, computers is an international transaction
– Imports such as French wine, Japanese cameras and
German automobiles are international transactions
– The purchase of a glass figure in Venice by an American
tourist is a US merchandise import
• Financial Account Transactions
– The purchase of a US Treasury bill by a foreign resident

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 BOP as a Flow Statement

• Exchange of Real Assets – exchange of goods and

services for other goods and services or for
monetary payment
• Exchange of Financial Assets – Exchange of
financial claims for other financial claims

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 The Current Account

• Goods Trade – export/import of goods.

• Services Trade – export/import of services; common
services are financial services provided by banks to foreign
investors, construction services and tourism services
• Income – predominately current income associated with
investments which were made in previous periods.
Additionally the wages & salaries paid to non-resident
workers
• Current Transfers – financial settlements associated with
change in ownership of real resources or financial items.
Any transfer between countries which is one-way, a gift or a
grant,is termed a current transfer
• Typically dominated by the export/import of goods, for this
reason the Balance of Trade (BOT) is widely quoted

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 The Capital and Financial Accounts

• Capital account is made up of transfers of fixed

assets such as real estate and acquisitions/disposal
of non-produced/non-financial assets
• Financial account consists of three components and
is classified either by maturity of asset or nature of
ownership. The three components are
– Direct Investment – Net balance of capital which is
dispersed from and into a country for the purpose of
exerting control over assets. This category includes foreign
direct investment

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 The Capital and Financial Accounts

– Portfolio Investment – Net balance of capital

which flows in and out of the country but does
not reach the 10% ownership threshold of
direct investment. The purchase and sale of
debt or equity securities is included in this
category
• This capital is purely return motivated
– Other Investment Assets/Liabilities – Consists of
various short and long-term trade credits,
cross-border loans, currency and bank deposits
and other accounts receivable and payable
related to cross-border trade

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 The Other Accounts

• Net Errors and Omissions – Account is used to account for

statistical errors and/or untraceable monies within a country
• Official Reserves – total reserves held by official monetary
authorities within a country.
– These reserves are typically comprised of major currencies that are used
in international trade and financial transactions and reserve accounts
(SDRs) held at the IMF
– Under a fixed rate regime official reserves are more important as the
government assumes the responsibility to maintain parity among
currencies by buying or selling its currency on the open market
– Under a floating rate regime the government does not assume such a
responsibility and the importance of official reserves is reduced

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 Exhibit 4.7 The United States Balance of
Payments, Analytic Presentation, 1995-
2005 (billions of U.S. dollars)

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 Exhibit 4.7 The United States Balance of
Payments, Analytic Presentation, 1995-2005
(billions of U.S. dollars) (cont.)

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 The Arab Republic Of Egypt Balance of Payments,
Analytic Presentation, 2020-2021 (Millions of U.S. dollars)
Press Release
Balance of Payments Performance in FY 2020/2021
The balance of payments records a surplus of about US$ 1.9 billion.

During FY 2020/2021, Egypt's transactions with the external world recorded

an overall surplus of US$ 1.9 billion, against a deficit of US$ 8.6 billion a year
Overall Balance earlier that was realized in the wake of COVID-19 pandemic. This improvement
proved the ability of the Egyptian economy to quickly recover from the crises that
hit the global economy.

Such an overall surplus was realized despite the fact that the current account deficit
rose to US$ 18.4 billion (against US$ 11.2 billion in the preceding FY). This rise,
however, was temporary mainly due to the noticeable drop in tourism revenues to
Current Account register less than half of the revenues realized in the corresponding year, affected by
the great shock that hit international tourism because of COVID-19 pandemic;
a crisis which the global economy is still suffering from.

The overall surplus came as the capital and financial account realized a net
inflow of about US$ 23.4 billion (compared with US$ 5.4 billion in the previous fiscal
Capital and Financial year). This reflects the noticeable improvement in foreign portfolio investments due to
Account the continuation of easing policies in global financial conditions, despite the
ongoing uncertainty caused by the COVID-19 pandemic; a matter that indicates the
confidence of foreign investors in the Egyptian economy .

The following is a review of the main developments in the BOP performance in FY 2020/2021 (relative to the previous FY 2019/2020).
1

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 The Arab Republic Of Egypt Balance of Payments,
Analytic Presentation, 2020-2021 (Millions of U.S. dollars)
(Cont.)
First: Current Account
✓The factors that triggered the widening of the current account deficit.
 The services surplus dropped by 42.9% to post only US$ 5.1billion (compared with US$ 9.0 billion), mainly due to:
o The decline in tourism revenues by 50.7% to record only US$ 4.9 billion (against US$ 9.9 billion).
o The contraction in transport receipts by 4.5% to stand at US$ 7.5 billion (against US$ 7.9 billion), mainly on the back of
the fall in the receipts of aviation companies impacted by COVID-19 pandemic, as well as in the receipts of ports’ logistics
services.
 The non-oil trade balance deficit widened by 16.7% to post US$ 42.1 billion (against US$ 36.0 billion), as the
increase in non-oil imports surpassed that of non-oil exports as illustrated below:
o Non-oil imports rose to US$ 62.1 billion, up by US$ 8.2 billion. Such a rise included the increase in the imports of
intermediate goods by US$ 3.3 billion and raw materials by US$ 736.3 million (both serving as inputs to production).
Imports of investment goods also scaled up by US$ 529.3 million, which helps improve the growth rate of the Egyptian
economy.
o Non-oil exports moved up by US$ 2.2 billion, to register US$ 20.1 billion, concentrated in exports of household electrical
appliances; inorganic and organic compounds; and wires and cables.
 Investment income deficit1 expanded by 9.2% to stand at US$ 12.4 billion (compared with US$ 11.4 billion), because
investment income payments went up by US$ 676.0 million, to register US$ 13.0 billion, reflecting the rise in both:
o Earnings of FDI in Egypt.
o Interest payments and dividends on foreigners’ investment in Egyptian bonds and securities.
Moreover, investment income receipts shrank by US$ 369.2 million, to only US$ 572.9 million, due to the decrease in
interest payments on deposits abroad.

1
It represents the difference between the income earned and paid from and to the external world on portfolio investment, direct investments, bank deposits and foreign debt.

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 The Arab Republic Of Egypt Balance of Payments,
Analytic Presentation, 2020-2021 (Millions of U.S. dollars)
(Cont.)

✓ The positive factors that helped mitigate the aggravation of the current account deficit.
 Workers’ remittances increased by 13.2% to post US$ 31.4 billion (compared with US$ 27.8 billion).
 The oil trade balance deficit improved to register only US$ 6.7 million (compared with US$ 421.0 million), owing to
the increase in oil exports by US$ 117.3 million to US$ 8.6 billion, and the decrease in oil imports by US$
297.0 million to US$ 8.6 billion.
Second: Capital and Financial Account
Net inflows of the capital and financial account rose to US$ 23.4 billion in FY 2020/2021, (compared with US$ 5.4 billion a
year earlier), as a result of the following main developments:
Portfolio investment in Egypt reversed to a net inflow of US$ 18.7 billion (against a net outflow of US$ 7.3 billion).
FDI in Egypt retreated, realizing a net inflow of only US$ 5.2 billion (against US$ 7.5 billion). Such a retreat came in
line with the decrease in global FDI as a natural effect of investors’ fears due to the continuing COVID-19 pandemic
worldwide, as illustrated hereunder:
First: Foreign direct investment in the oil sector:
Investment in the oil sector reversed into a net outflow of US$ 1.2 billion, against a net inflow of US$ 1.1 billion in the preceding
year. This was driven by achieving inflows of US$ 5.1 billion by foreign oil contractors minus outflows of US$ 6.3 billion (as a
cost recovery for the exploration, development and operations previously incurred by foreign partners).
Second: Foreign direct investment in the non-oil sectors:
FDI in non-oil sectors slightly increased by US$ 70.2 million, achieving a net inflow of US$ 6.4 billion with a growth rate
of 1.1%. This was a combined result of the rise in:
A.Inflows for greenfield investment by 24.7% to reach US$ 77.8 million.
B.Net retained earnings and credit balances surplus by 11.5% to amount to US$ 4.4 billion.
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 The Arab Republic Of Egypt Balance of Payments,
Analytic Presentation, 2020-2021 (Millions of U.S. dollars)
(Cont.)

and the decline in:

1- Net inflows for capital increases of existing companies by US$
259.6 million to post only US$ 1.2 billion.
2- The proceeds from selling local entities to non-residents by US$
89.2 million to record US$ 54.5 million.
3- Inflows for real estate purchases in Egypt by non-residents by US$
49.8 million, to stand at US$ 616.4 million.
 Medium- and long-term loans and facilities recorded a net disbursement of US$ 6.4 billion (against US$ 6.6 billion).
 Short-term trade credit realized a net disbursement of US$ 1.5 billion (against a net repayment of US$ 2.0 billion).

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 The Arab Republic Of Egypt Balance of Payments,
Analytic Presentation, 2020-2021 (Millions of U.S. dollars)
(Cont.)

Balance of Payments
2019/20* 2020/21* (US$ m.)
Trade Balance -36465.1 -42059.6
Exports 26376.0 28676.5
Petroleum 8479.9 8597.2
Other Exports 17896.1 20079.3
Imports -62841.1
-70736.1
Petroleum -8900.9 -8603.9
Other Imports -53940.2 -62132.2
Services Balance (net) 8972.5 5119.0
Receipts 21288.9 15995.1
Transportation 7881.1 7527.7
of which: Suez Canal dues 5805.7 5911.2
Travel 9859.4 4861.5
Government Receipts 758.5 513.1
Other 2789.9 3092.8
Payments 12316.4 10876.1
Transportation 2050.1 1812.2
Travel 3213.0 2708.2
Government Expenditures 975.8 1246.6
Other 6077.5 5109.1
Income Balance (net) -11354.0 -12399.2
Income receipts 942.1 572.9
Income payments 12296.1 12972.1
of which: Interest Paid 2947.7 2518.7
Transfers 27679.9 30903.4
Private Transfers (net) 27461.8 31180.3
of which: Worker Remittances 27758.0 31425.3
Official Transfers (net) 218.1 -276.9
Current Account Balance -11166.7 -18436.4

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 The Arab Republic Of Egypt Balance of Payments,
Analytic Presentation, 2020-2021 (Millions of U.S. dollars)
(Cont.)

Balance of Payments (cont.)

2019/20* 2020/21* (US$ m.)
Capital & Financial Account 5374.6 23374.0
Capital Account -248.5 -153.0
Financial Account 5623.1 23527.0
Direct Investment Abroad -351.2 -379.1
Direct Investment In Egypt (net) 7453.0 5214.2
Portfolio Investment Abroad(net) -818.1 -750.7
Portfolio Investment in Egypt (net) -7307.3 18742.4
of which: Bonds 4594.9 4548.9
Other Investment (net) 6646.7 700.2
Net Borrowing 4541.6 7964.7
M&L Term Loans (net) 7216.8 4263.7
Drawings 9253.1 6502.4
Repayments -2036.3 -2238.7
MT Suppliers Credit (net) -644.9 2173.6
Drawings 34.3 3304.1
Repayments -679.2 -1130.5
ST Suppliers Credit (net) -2030.3 1527.4
Other Assets -100.4 -6039.4
Central Bank -231.7 -115.4
Banks 4306.4 -5014.6
Other -4175.1 -909.4
Other Liabilities 2205.5 -1225.1
Central Bank -141.0 -2734.9
Banks 2346.5 1509.8
Net Errors & Omissions -2795.1 -3075.9
Overall Balance -8587.2 1861.7
Change in CBE's reserve assets (increase = -) 8587.2 -1861.7

* Preliminary.

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 Balance of Payments Interaction
with Key Macroeconomic Variables

• A nation’s balance of payments interacts

with nearly all of its key macroeconomic
variables:
– Gross domestic product (GDP)
– The exchange rate
– Interest rates
– Inflation rates

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 Balance of Payments Interaction with Key
Macroeconomic Variables

• In a static (accounting) sense, a nation’s

GDP can be represented by the following
equation:
GDP = C + I + G + X – M

C = consumption spending
I = capital investment spending
G = government spending
X–M=
X = exports of goods and services
M = imports of goods and services Current account
balance

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 The Balance of Payments and
Exchange Rates

• A country’s BOP can have a significant impact on

the level of its exchange rate and vice versa
depending on that country’s exchange rate regime
• The effect of an imbalance in the BOP of a country
works somewhat differently depending on whether
that country has fixed exchange rates, floating
exchange rates, or a managed exchange rate
system
– Under a fixed exchange rate system the government
bears the responsibility to assure a BOP near zero
– Under a floating exchange rate system, the government
of a country has no responsibility to peg its foreign
exchange rate

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 The Balance of Payments and
Exchange Rates

• The relationship between BOP and exchange

rates can be illustrated by use of a simplified
equation:
Current Capital Financial Reserve Balance
Account Account Account Balance of
Balance + Balance + Balance + = Payments
(X-M) (CI - CO) (FI - FO) (FXB) BOP

CI = capital inflows
CO = capital outflows
FI = financial inflows
FO = financial outflows
FXB = official monetary reserves

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 The Balance of Payments and
Interest Rates

• Apart from the use of interest rates to intervene in

the foreign exchange market, the overall level of a
country’s interest rates compared to other
countries does have an impact on the financial
account of the balance of payments
• Relatively low interest rates should normally
stimulate an outflow of capital seeking higher
interest rates in other country-currencies
• In the U.S. however, the opposite has occurred as
a result of attractive growth rate prospects, high
levels of productive innovation, and perceived
political stability

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 The Balance of Payments and
Inflation Rates

• Imports have the potential to lower a country’s

inflation rate
• In particular, imports of lower priced goods and
services places a limit on what domestic
competitors charge for comparable goods and
services

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 Trade Balances and Exchange Rates

• A simple concept in principle: Changes in

exchange rates changes the relative prices of
imports and exports which in turn result in
changes in quantities demanded
• In reality the process is less straight-forward

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 The J-Curve Adjustment Path

• Trade balance adjustment occurs in three stages

over a varying and often lengthy period of time
1. The currency contract period
– Adjustment is uncertain due to existing contracts that
must be fulfilled
2. The pass-through period
– Importers and exporters must eventually pass along the
cost changes
3. Quantity adjustment period
– The expected balance of trade is eventually realized

– U.S. trade balance = (P$xQx) – (S$/fc PfcM QM)

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 Exhibit 4.8 Trade Balance Adjustment to
Exchange Rate Changes: The J-Curve

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 Summary of Learning Objectives

• The Balance of Payments is the summary

statement of all international transactions between
one country and all other countries
• The Balance of Payments is a flow statement,
summarizing all the international transactions that
occur across the geographic boundaries of the
nation over a period of time, typically a year
• Although the BOP must always balance in theory,
in practice there are substantial imbalances as a
result of statistical errors and misreporting of
current account and financial/capital account flows

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 Summary of Learning Objectives

• The two major sub-accounts of the balance of

payments, the current account and the
financial/capital account, summarize the current
trade and international capital flows of the country
respectively
• The current account and financial/capital account
are typically inverse on balance, one in surplus
while the other experiences deficit
• Although most nations strive for current account
surpluses, it is not clear that a balance on current
or capital account, or a surplus on current
account, is either sustainable or desirable

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 Summary of Learning Objectives

• Although merchandise trade is more easily

observed, the growth of services trade is more
significant to the BOP for many of the world’s
largest industrialized countries today
• Monitoring of the various sub-accounts of a
country’s BOP activity is helpful to decision-
makers and policy-makers on all levels of
government and industry in detecting the
underlying trends and movement of fundamental
economic forces driving a country’s international
economic activity

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 Summary of Learning Objectives

• Changes in exchange rates change relative prices of imports

and exports which in turn result in changes in quantities of
demanded through the elasticity of demand
• A devaluation results initially in a further deterioration in the
trade balance before an eventual improvement – the path of
adjustment takes on the shape of a flattened “j”

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