CERAM (c)

The Balance of Payments IICapital Account

International FinanceCFVG-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: Double bookkeeping: SSummary statementummary statement that records that records as a credit (+) any transaction resulting in a receipt from the as a credit (+) any transaction resulting in a receipt from the rest of the world and as a debit (-) any transrest of the world and as a debit (-) any transaaction resulting ction resulting in a payment in a payment

These transactions lead to changes in supply and demand These transactions lead to changes in supply and demand for foreign exchange, hence an impact on exchange rates, for foreign exchange, hence an impact on exchange rates, reserve assets and on foreign exchange markets reserve assets and on foreign exchange markets

CERAM (c)

Risk assessment is rooted in balance of payments analysis!

1. Trade flows and competitiveness 2. Structural or short-term deficits?

3. Exchange rate variations4. External financing flows

5. Capital flight6. Debt crisis!

CERAM (c)

US Current account deficit

-800

-700

-600

-500

-400

-300

-200

-100

0

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008-7% PBI

US Treasury, IMF

US$ billion

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Major net Importers of Capital

Source: IMF 2007

CERAM (c)

Major net Exporters of Capital

Source: IMF 2007

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* 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 $weaker $

BUT need to finance the deficit by attracting US$2,4 billion/day foreign capital inflows with stronger $!with stronger $!

Capital sources = surplus countries = Germany + China + Japan + India + Korea

Need to maintain positive real interest rates to enhance the dollar attractiveness and competitivenessdollar attractiveness and competitiveness

Engine of world growth ?Engine of world growth ?

CERAM (c)

The US CAD dilemma… revisited (1)

Large US CAD, though:

1. The US net liabilities have risen less than the cumulative CAD

2. Decline in US net liabilities/GDP3. Minimal debt servicing burden (the global status of the $ leads to

massive purchases of UST bills, hence low rate of interest)

NYFed staff report n°271 12/2006

CERAM (c)

The US CAD dilemma… revisited (2)

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

1. Use of the dollar in international trade transactions (all US exports and imports are invoiced in $, hence insensitivity to exchange rate changes): Asia

2. Market share concern of foreign exporters, hence desire to remain competitive in the large US market)

3. 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

Fed RB NY, June 2007

CERAM (c)

Capital accountCapital account

– Reflects changes in country’s 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

Services (shipment, travel)

Investment Income

Official transfers

Workers’ remittances

FDI (equity capital)

Portfolio Investment

Long-term Capital Inflows

Short-term Capital Inflows

Reserve Increase

Imports of Goods

Payments of services

Long-term Debt Payments

Short-term Debt Payments

Reserve Decrease

CERAM (c)

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).

The Financial Account, however, uses a third method. This focuses on the degree of investor control over the assets or operations.

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 short-term 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

Paris Club (government to government credits)

Export insurance credit agencies (Eximbanks)

IFIs RDBs

PrivatePrivate

FDI Portfolio Investment London Club (International

bank loans; company-to-company bank loans)

Working capital lines Shortterm Trade credits Bonds & International debt

securities

CERAM (c)

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

CERAM (c)

Where do capital flows goWhere do capital flows go??

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Who finances whom?Current account balances of OECD (30) and EMCs (160)

-700

-500

-300

-100

100

300

500

700

EMCs OECD

US$ billion

Source: IIF, IMF-WEO 2009

CERAM (c)

EMCs shrinking current account surpluses

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Net external capital sources for EMCs

-100

100

300

500

700

900

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

privatepublic

IIF/IMF

US$ billion

CERAM (c)

Private flowsPrivate 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)

0

100

200

300

400

500

600

700

800

900

1000

1990 1996 1998 2000 2002 2004 2006 2008

TotalAsiaLat AmericaAfrica

Billion of US$

Source: IIF/IMF

CERAM (c)

Net FDI and portfolio capital flows to EMCs

0

50

100

150

200

250

300

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

Equity

ASIA

Latin America

US$ billion

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 managementactive role in the management of the enterprise whose assets are being acquired.

When the investor’s 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 enterprise’s 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)

FDI’s Benefits and challenges

Benefits Challenges

Additional resources available for  productive investment Risk sharing with the rest of the world (equity)Greater external market discipline on macroeconomic policyGreater exploitation of comparative economic advantagesEnhanced access to technology, information, ideas and management skillsBroader access to export markets through foreign partners Training and  broader exposure of national staffGreater liquidity to meet domestic financing needsBroadening and deepening of national capital marketsImprovement of financial sector skills

Currency appreciation Reduced  scope for independent macroeconomic policy actions Greater exposure to external shocks Demands for protection in local marketsLesser control of foreign owned domestic industryDisruption 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 in % of total volume

0

2

4

6

8

10

12

14

16

USA UK China/HK France Netherlands Canada Germany Belgium Spain Russia

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

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

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 asprivatisation tails off and the global economy slows.

CERAM (c)

OECD* (65%)

EMCs (35%)

ASIA (50%)LATIN

AMERICA

(25%)

GLOBAL ECONOMYGLOBAL ECONOMY EMCsEMCs

LATIN LATIN

AMERICAAMERICA MEXICO (15%)

CHILE (10%)

PERU (4%)

CHINA (36%)

ASIAASIA

GLOBAL FDI FLOWS 2008 = $1500 billion GLOBAL FDI FLOWS 2008 = $1500 billion

Source: IIF, OECD/UNCTAD

$92 billion

* 30 countries - Mexico

CERAM (c)

30 most attractive Emerging markets

for FDI

1. India2. Russia3. Vietnam4. Ukraine5. China6. Chile7. Latvia8. Slovenia9. Croacia10. Turkey11. Tunisia12. Thailand13. Korea14. Malaysia15. Macedonia16. UAE17. Arabia Saudita18. Slovakia19. México20. Egypt21. Bulgaria22. Rumania23. Hungary24. Taiwan25. Bosnia26. Lituania27. Brasil28. Morroco29. Colombia30. Kazajstan

Σ Economic + Political riskMarket potentialAT Kearney GRDI

CERAM (c)

TOP 25 Global Confidence Index

AT Kearney 2007

CERAM (c)

Most attractive emerging markets

HighRisk

LowsRisk

CERAM (c)

China: FDI Flows

0102030405060708090

100InflowsOutflows

In billions of US$

Source: OECD

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)

0

1000

2000

3000

4000

5000

6000

7000

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

In millions of US$, actual disbursed as of 08

Source: IMF

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

CERAM (c)

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?1. USA

2. South Korea

3. Hongkong

4. UK

5. Taiwan

6. Singapore

7. Japan

8. France

9. Netherlands

10. Malaysia

WHERE?

Sectors Industry

Real estate Oil

Mining Tourism

60%

CERAM (c)

FDI in Vietnam by Sector

CERAM (c)

TOP 10 INVESTOR NATIONS IN VIETNAM

CERAM (c)

Contribution of FDI to Vietnam’s 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

FDI Flows and Outflows in US$ 1975-2007

-250

-200

-150

-100

-50

0

50

100

150

200

1975 1978 1981 1984 1987 1990 1993 1996 1999 2002 2005

OUT

INRatio OUT/IN= 1,8Ratio OUT/IN= 1,8

Source: FMI & OCDE 2008Source: 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 capitalNon-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 LACsOverall Disbursements from private creditors in US$

0

20000000000

40000000000

60000000000

80000000000

100000000000

120000000000

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: (member’s 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 non-marketable 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.

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

CERAM (c)

Vietnam’s foreign exchange reserves

0

5000

10000

15000

20000

25000

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

CERAM (c)

China’s rising official reserve assets

0200

400

600800

1000

1200

14001600

1800

2000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

US$ billion

Source: IMF 2006/IIF

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 omissions5. 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)

EMCs: Errors and omissions, net

-80 000

-60 000

-40 000

-20 000

0

20 000

2001 2002 2003 2004 2005 2006e 2007f

In millions of US$ Source: IIF

CERAM (c)

Vietnam’s 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 & OmissionsNet Errors & Omissions US$ billion

-25000

-20000

-15000

-10000

-5000

0

5000

10000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Source: IMF-IFS/IIF

CERAM (c)

Peru and Capital flightPeruvian non-bank private external deposits in international banks overseas in

US$ million

0

500

1000

1500

2000

2500

3000

3500

4000

4500

-1000

-800

-600

-400

-200

0

200

400

600

800

Stock

Change in flows

CERAM (c)

6. Exceptional Financing

IMF Drawings World Bank’s HIPC Initiative London Club debt reduction and

restructuring workouts Paris Club debt relief Debt swap transactions

CERAM (c)

IMF Disbursements and Repayments

0

5000

10000

15000

20000

25000

30000

35000 In SDR million

Credits

Repayments

CERAM (c)

Total IMF Credit Outstanding for all Members Encours de prêts du Fonds Monétaire International en millions de dollars

0

20000

40000

60000

80000

100000

120000

1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

CERAM (c)

+ 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

Risk Management and BOP Analysis

CERAM (c)

External Finance Analysis:The dual face of Country Risk

Liquidity 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

Solvency Risk(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

-3000

-2500

-2000

-1500

-1000

-500

0

500

NEP

Source: IMF-2009

International assets-International Liabilities

CERAM (c)

Net US external investment position in US$ billion

FRB of NY: Current issues in economics and finance, December 2005, N°12:

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 IStage 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 IIStage 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 IIIStage 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 IVStage 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 VStage 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.