This is the streamed version of a revision webinar on the balance of payments.

1. Revision Webinar on the Balance of
Payments

2. Quick Quiz on the Balance of Payments
In 2016, what was the final value of the UK balance of
payments
A deficit of £80bn A surplus of £45bn
Zero
It was impossible to
calculate

3. Question 2

4. Question 3

5. Question 4

6. Question 5

7. Overview of the Balance of Payments

8. The Current Account
• Current Account
• (1) Balance of trade in goods
• (2) Balance of trade in services
• (3) Net primary income (interest, profits, dividends and
migrant remittances)
• (4) Net secondary income (transfers i.e. contributions
to EU, military aid, overseas aid)
Note: The X-M (trade balance) is the figure used when calculating
aggregate demand
Note: FDI coming into the country will be a surplus on the financial
account but the repatriation of that firm’s profits back to its home
country will be a deficit on the current account

9. Items included in the current account of the BoP
• Finished manufactured goods, components,
raw materials
• Energy products, Capital technology
Trade Balance in
Goods
• Banking, Insurance, Consultancy
• Tourism, Transport, Logistics
• Shipping, Education, Health,
• Research, Cultural Arts
Trade Balance in
Services
• Profits, interest and dividends from investments
in other countries
Net remittance flows rom migrant workers
Net Primary Income
from Overseas
Assets
•Overseas aid / debt relief
•Military grants
•UK Payments to the European Union
Net Secondary
Income

10. The Capital Account
• Capital account
• Sale/transfer of patents, copyrights, franchises, leases
and other transferable contracts (example would be
international buying and selling of land by businesses)
• Debt forgiveness/cancellation (forgiving debt counted
as a negative)
• Capital transfers of ownership of fixed assets (i.e.
international death duties)
Note: The old capital account is now called the financial account. The
capital account in the new Balance of Payments system is now a tiny
part of the overall figure

11. The Financial Account
• Financial Account – includes transactions that result in a
change of ownership of financial assets and liabilities
between UK residents and non-residents
1. Net balance of foreign direct investment flows (FDI)
2. Net balance of portfolio investment flows (e.g.
inflows/outflows of debt and equity)
3. Balance of banking flows (e.g. hot money flowing
in/out of banking system)
4. Changes to the value of reserves of gold and foreign
currency

12. What is Foreign Direct Investment?
• FDI is investment from one country into another (normally
by companies rather than governments) that involves
establishing operations or acquiring tangible assets,
including stakes in other businesses
• Foreign direct investment flows:
1. Inward investment is a positive for the UK accounts
• E.g. an overseas business decides to build a manufacturing
factory in the UK
• A foreign retail firm invests to open new stores in the UK
2. Outward investment is a negative for the UK financial
account of the balance of payments
• Investment made overseas by UK businesses

13. What is Portfolio Investment?
• Portfolio investment happens when people / businesses
from one country buy shares or other securities such as
bonds in other nations.
• For example:
1. A UK investor might buy some shares in Google
(portfolio investment outflow for the UK)
2. A German investment bank might buy some of the
sovereign debt issued by the UK government (a portfolio
investment inflow for the UK)
• With share/equity investments , the standard definitions
of control use the internationally agreed 10% threshold of
voting shares although smaller % shares might be enough
to gain some ownership control/influence of bigger
companies

14. Balance of Payments Accounts in Summary
• Current Account
• (1) Balance of trade in goods
• (2) Balance of trade in services
• (3) Net primary income (interest, profits, dividends and migrant remittances)
• (4) Net secondary income (transfers i.e. contributions to EU, military aid, overseas aid)
• Capital account
• Sale/transfer of patents, copyrights, franchises, leases and other transferable
contracts (example would be international buying and selling of land by businesses)
• Debt forgiveness/cancellation (forgiving debt counted as a negative)
• Capital transfers of ownership of fixed assets (i.e. international death duties)
• Financial Account – includes transactions that result in a change of ownership of financial
assets and liabilities between UK residents and non-residents
• Net balance of foreign direct investment flows (FDI)
• Net balance of portfolio investment flows (e.g. inflows/outflows of debt and equity)
• Balance of banking flows (e.g. hot money flowing in/out of banking system)
• Changes to the value of reserves of gold and foreign currency
• Balancing item (estimated net errors & omissions)
• Overall balance of payments = zero

15. UK balance of payments in context
• The current account balance plus the financial account
measures the extent to which the UK is a net lender (that
is, in surplus) or net borrower (that is, in deficit).
• Countries that run current account deficits have to be net
borrowers in the international financial system.
• This is the case for the UK at present with a current
account deficit in 2015 of more than 5% of UK GDP
• Countries that run current account surpluses can be net
lenders i.e. they can export surplus US $s etc. in overseas
investment – a good example is China and their purchase
of US treasuries + investments made by Sovereign Wealth
Funds.
• Norway and Singapore also run huge trade surpluses

16. UK Trade Balance in Goods and Services
-8
-6
-4
-2
0
2
4
6
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
Annual trade balance measured as a percentage of GDP
Total trade balance Trade in goods balance Trade in services balance

17. UK Current Account Balance – 2000 to 2015
-1.9
-2.3
-2.8
-2.4 -2.7 -2.6 -2.5 -2.6
-3
-2.3
-2.7
-1.7
-2.2 -2.3 -2 -2.1
0.7 1
1.6 1.7 1.8
2.4
1.1 1.1
0.3 0.4
1.3 1.2
-0.1
-0.6 -1.3
-2
-0.9
-0.6
-0.8
-0.9
-0.8 -0.9 -0.9 -0.9
-0.9
-1
-1.3
-1.3
-1.3
-1.5
-1.4
-1.3
-6
-5
-4
-3
-2
-1
0
1
2
3
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
UK Current Account of the Balance of Payments (% of GDP)
Trade balance Primary balance Secondary balance

18. UK Current Account Balance – The Long Run
-120000
-100000
-80000
-60000
-40000
-20000
0
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
BoP Current Account Balance – Annual - £ million
Financing the Current Account Deficit
The UK is running a historically high current account
deficit and this needs to be financed by net inflows on
the financial account of the balance of payments. In July
2016, the Bank of England noted that: “The financing of
the UK external deficit is reliant on continuing inflows of
portfolio and foreign direct investment, which have been
used to finance the fiscal deficit and corporate
investment, including in commercial real estate.”

19. Meaning of a deficit & a surplus on the current account
Current account deficit
This is an external deficit
Net outflow of income from the economy’s
circular flow
Deficit countries need to run a financial
account surplus
Might be achieved by attracting inflows of
financial capital from other countries
Current account deficit nations are debtor
countries
Current account surplus
This is an external surplus
Net inflow of income into the economy
Allows a country to run a financial account
deficit
External surplus countries may use
accumulated foreign currency reserves to
establish a sovereign wealth fun
Current account surplus nations are
creditor nations

20. Meaning of a deficit & a surplus on the current account
Current account deficit
This is an external deficit
Net outflow of income from the economy’s
circular flow
Deficit countries need to run a financial
account surplus
Might be achieved by attracting inflows of
financial capital from other countries
Current account deficit nations are debtor
countries
Current account surplus
This is an external surplus
Net inflow of income into the economy
Allows a country to run a financial account
deficit
External surplus countries may use
accumulated foreign currency reserves to
establish a sovereign wealth fun
Current account surplus nations are
creditor nations

21. Key Causes of a Current Account Deficit
Poor price and non-price competitiveness
• Higher inflation than trading partners
• Low levels of capital investment and research
• Weaknesses in design, branding, product performance
Strong exchange rate affecting demand for exports and imports
• High currency value increases prices of exports
• Appreciating currency also makes imports cheaper
Recession in one or more major trade partner countries
• Recession cuts value of exports to these countries
• Might be barriers to switching to other markets e.g. UK businesses struggle to sell
to emerging markets such as India, Vietnam, Mexico
Volatile global prices (e.g. soft and hard commodities)
• Exporters of primary commodities might be hit by a fall in world prices
• Importing nations could be hit by higher prices for oil and gas, raw materials

22. Expenditure Switching and Expenditure Reduction
Expenditure Switching Policies
• These are policies designed to change the relative
prices of exports and imports
• For example - an exchange rate depreciation ought to
improve the price competitiveness of exports and also
make imports more expensive
Expenditure Reducing Policies
• Policies designed to lower real incomes and aggregate
demand and thereby cut demand for imports
• E.g. higher direct taxes and an increase in interest rates

23. Expenditure Switching and Expenditure Reduction
Expenditure Switching Policy Instrument of Policy Evaluative Comment
Depreciation of the exchange
rate
Reduces relative price of
exports & makes imports
more expensive
Risk of cost-push inflation –
which erodes competitive
boost + fall in real incomes
Import tariffs Increases the price of imports
& makes domestic output
more price competitive
Risk of retaliation from other
countries if import tariffs are
used as BoP policy
Low rate of inflation (perhaps
deflation)
Keeps general price level
under control and makes
exports more competitive
Risks from deflation as a way
of achieving internal
devaluation – including lower
investment

24. Expenditure Switching and Expenditure Reduction
Expenditure Switching Policy Instrument of Policy Evaluative Comment
Depreciation of the exchange
rate
Reduces relative price of
exports & makes imports
more expensive
Risk of cost-push inflation –
which erodes competitive
boost + fall in real incomes
Import tariffs Increases the price of imports
& makes domestic output
more price competitive
Risk of retaliation from other
countries if import tariffs are
used as BoP policy
Low rate of inflation (perhaps
deflation)
Keeps general price level
under control and makes
exports more competitive
Risks from deflation as a way
of achieving internal
devaluation – including lower
investment
Expenditure Reducing Policy Instrument of Policy Evaluative Comment
Increase in income taxes Reduces real disposable
incomes causing falling
demand for imports
Cut in living standards and
risk of damage to work
incentives in labour market
Cuts in real level of
government spending
Lowers aggregate demand,
firms may look to export their
spare capacity
Damage to short term
economic growth, risks that
austerity hits investment

25. Question 6

26. Question 7

27. The J Curve following a depreciation
Time period after
depreciation
Trade
surplus
Trade
deficit
Currency
depreciation
here
Trade deficit may
grow in initial
period after
depreciation
The diagram below shows the “J Curve effect” – it shows the time
lags between a falling currency and an improved trade balance

28. The J Curve following a depreciation
Time period after
depreciation
Trade
surplus
Trade
deficit
Currency
depreciation
here
Trade deficit may
grow in initial
period after
depreciation
Net improvement
in trade provided
certain conditions
are met
The diagram below shows the “J Curve effect” – it shows the time
lags between a falling currency and an improved trade balance

29. Some Key Terms

30. Balance of Payments Key Terms
• The balance of payments (BOP) records all financial
transactions made between consumers, businesses and
the government in one country with other nations
• Inflows of foreign currency are counted as a positive entry
(e.g. exports sold overseas) – they are credit items
• Outflows of foreign currency are counted as a negative
entry (e.g. imported goods and services) – they are debit
items
• The current account of the balance of payments is the
main measure of external trade performance
• The financial account measures inflows and outflows of
financial capital across national boundaries
Key term Brief definition
Balance of Payments imbalances Persistent deficits or surpluses mainly on the current account
Current account balance
The current account measures the difference between money
and credit going in and out of an economy (through exports,
imports and income paid on assets both home and abroad)
Current account surplus When net external trade and income is positive
Current account deficit
When net external trade and income is negative leading to a net
outflow of demand from the circular flow
Effective exchange rate index The trade-weighted external value of a currency
Financial flows Flows of capital across national borders including debt and equity
Excess savings When gross national savings > gross capital investment
Capital (financial) account (BoP) Balance of investment flows into and out of a country
Depreciation Fall in the external value of one currency against another
Marshall Lerner Condition
A devaluation of a currency improves the BoP only if the
combined (or sum of) price elasticities of demand for imports &
exports are greater than one.

31. @tutor2ugeoff

32. Balance of Payments