# National Accounts and Balance of Payments

What is a country's external position?

How does it relate to GDP or national savings?

What are the different items in the balance of payments?

How can these different items be interpreted correctly?

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# National accounts reminders

## GDP and NI

Gross domestic product GDP (territorial perspective) :

${\displaystyle GDP\equiv C+I+G+EXP-IMP}$ [1]

Gross National Income (GNI) and National Income (NI) (residency perspective) :

NB: PIB et RNB liés, mais, pays débiteurs (créditeurs) → PIB > (<) RNB.

## GDP and its components

GDP = sum of value added of all goods and services produced in the country.

## GDP and GNI: an example

As we have just seen, GDP and GNI do not coincide. In particular, for a debtor country (net importer of capital or labour services) the ${\displaystyle GDP>GNI}$ → Example: Ireland

NFIA = net factor income from abroad (= SBRF).

## Absorption and current account balance

Simplification in the model: capital depreciation, taxes and subsidies assumed to be negligible --> "${\displaystyle Y}$" is both national product and national income :

${\displaystyle Y\equiv C+I+G+EXP-IMP+SBRF+SBTC(\cong RN)}$

Condensed notation :

${\displaystyle Y\equiv A+CC}$ [2]

where:

${\displaystyle A\equiv C+I+G}$ : absorption (dépense intérieure)
${\displaystyle CC\equiv EXP-IMP+SBRF+SBTC}$ : solde balance courante (ou compte courant)
${\displaystyle \Leftrightarrow CC\equiv Y-A\equiv \Delta AEN}$ (flux)

NB: if ${\displaystyle A>Y}$ → current account deficit financed by net debt (${\displaystyle NEA}$↓)

where:

${\displaystyle NEA\equiv net\ foreign\ assets}$ (or rest of the world, RW) [3]
${\displaystyle NEA\equiv receivables\ from\ RW-liabilities\ to\ RW}$

## Savings, government deficit and current account

In an open economy, the current account is the difference between income and expenditure (or absorption) and reflects the change in net foreign assets over the period = the financing capacity of the economy.

Allocation of income:

${\displaystyle Y\equiv C+S^{P}+T}$ (${\displaystyle S^{P}}$ = private saving, ${\displaystyle T}$ = taxes) [4]

Combined with ${\displaystyle Y\equiv C+I+G+CC}$ we get:

${\displaystyle S^{P}+(T-G)\equiv I+CC}$ [5]

In an open economy, savings lead either to an increase in the capital stock or to an increase in NEAs.

Or, as ${\displaystyle S=S^{P}+S^{g}}$ and ${\displaystyle S^{g}=T-G}$ :

${\displaystyle S^{P}\equiv I+CC-S^{g}}$ [5']

The surplus of private savings over I is used to finance the government deficit and the current account. Put differently, domestic investment can be financed by savings or by a current account deficit.

## Implications of identities

An open economy can save either by developing its capital stock (as in a closed economy) or by acquiring external assets (example of intertemporal trade: the NZ building a new hydropower plant).

Equation [5] is a fundamental accounting identity, but not an economic model → beware of misinterpretation. Example: KO case study 13.1: the case of 'twin deficits'. USA early 1980s: expansive fiscal policy → public deficit → CC deficit. EU in the 1990s: the reduction of EU deficits - to meet the Maastricht criteria - did not result in a CC surplus. Why not? Because private savings decreased almost as much as the increase in public savings (possible explanation: Ricardian equivalence). → No automatism → Need for an economic model that EXPLAINS the links between the variables involved in identity.

# The balance of payments

## General principles

All international transactions are recorded in the balance of payments.

Any transaction that leads to foreign exchange earnings from abroad (exports of goods or assets) is recorded with a positive sign indicating a credit (+).

→ supply of foreign currency (or demand for domestic currency).

Any transaction that leads to a payment in foreign currency abroad (import of goods or import of assets) is accounted for with a negative sign indicating a debit (-)

→ demand for foreign currency (or supply of domestic currency).
→ If ${\displaystyle H}$ is Switzerland, any transaction leading to a demand (offer) of CHF is recorded as a credit (debit).

## Types of transactions

Two kinds of transactions (but three accounts!) :

• Purchase or sale of goods and services. Transactions recorded in the current account (CC). An import purchase from a resident in ${\displaystyle H}$ gives rise to a debit of the CC of ${\displaystyle H}$ (and a credit of the CC of ${\displaystyle F}$), as payment in foreign currency in return.
• Purchase or sale of assets. Transactions recorded in the financial account (CF) or in the capital account (CK). For example, a resident of H buys shares in a company of ${\displaystyle F}$ (increase in foreign assets held by residents of ${\displaystyle H}$). The CF of ${\displaystyle H}$ is debited because there is demand for currency and credit in the CF of ${\displaystyle F}$.

## Balance of payments: simplified structure

Interpretation: CC indicates the net financing capacity of the economy relative to the RDM (e.g. a surplus of 100), and CK,CF indicate how this capacity materializes (e.g. a debt reduction of 20 = ↘ of domestic assets held by RDM and a debt increase of 80 = of foreign assets held by residents) => the balance of payments is always in equilibrium.

## The principle of double writing

Each international transaction automatically enters the PB twice, once as a debit, once as a credit (again, the balance of payments is always in balance).

Ex. 1: The company PRECISA from Geneva sells watch cases to its French customer ARTHUS from Besançon. ARTHUS pays the customer:

(i) by liquidating its cash voucher position at the BCG.
(ii) by drawing a cheque on its Belfort CA account. PRECISA takes the opportunity to increase the French securities it already holds with the CA.

Ex. 2: Fiduciary BONCOMPTE of Geneva imports computer equipment produced by the company OLIVETTO of Turin. It does so:

(i) by selling all its FIAT shares deposited in Banco M of Turin.
(ii) by obtaining a loan from Banco M of Turin.

## Trade balance (labour and capital income)

Debit: Income from labour and capital paid abroad

Source : BNS.

## Factor income balance: details

Income from work:

• Payments to foreign cross-border commuters working in Switzerland;
• Salaries received by persons working for international organisations in Switzerland.

Income from capital:

• Income from securities (shares, bonds);
• Income from direct investments;
• Income from investments of the National Bank and the Confederation.

Source : BNS.

## Current transfers balance: details

Current transfers from the private sector:

• transfers from Swiss emigrants;
• Transfers from foreign insurance institutions;
• Transfers from foreign immigrants.

Current transfers from the public sector:

• Social insurance contributions by Swiss abroad;
• State revenue from withholding tax;
• Social insurance benefits paid abroad;
• contributions to international organisations.

## Balance of capital transactions

Debit: Payments related to the movement of capital from the country to abroad (purchase of a foreign security)

Credit: Payments related to the movement of capital from abroad into the country (sale of a domestic security)

Capital account (CK) = any asset transaction not listed in the CF

Financial Account (FA) = private transactions, (FC) and official reserves (or "reserve assets", RES)

Source : BNS.

## Capital account balance: detail

Capital account (CK) = any asset transactions not listed in the CF.

• Capital transfers = transfer of ownership without consideration. Two types: (i) debt forgiveness (= cancellation) and (ii) other transfers (e.g. transfers of migrants' property).

Financial account (FC). Composed of five categories:

• Direct investment = when the investor has a lasting interest and seeks to influence the management of the "invested" company (holding more than 10% of the voting rights or failing that of the share capital).
• Portfolio investment = non-temporary transactions in marketable securities (shares, bonds).
• Financial derivatives = transactions on options and futures markets.
• Other investments = trade credits, loans and miscellaneous deposits.
• Reserve assets = transactions in international reserves held by the Central Bank.

## Net change in official reserves

Transactions on international reserves (foreign exchange, gold, Special Drawing Rights (SDRs), reserve position with the IMF) held by the Central Bank.

Debit: An increase in reserves

Credit: A decrease in reserves

A surplus on the balance of accounts increases official gold and foreign exchange reserves; a deficit decreases them.

Source : BNS.

Algebraically adding the balance of the balance of accounts and the net change in official reserves gives the balance of the balance of payments equal to zero.

## Residual item: Errors and omissions

All transactions are theoretically recorded on both the revenue and expenditure sides, so the two totals should be equal. In practice, this is not the case.

The residual item is the difference between the total "revenue" and the total "expenditure".

This difference is due to gaps and errors in the statistical records.

Source : BNS.

Source : BCE.

## Current account and movement of capital

Any transaction in the current account (CC) is settled by a transaction in the capital movements balance (CF) = change in the country's stock of assets and liabilities vis-à-vis other countries.

The reverse is not necessarily correct: a transaction originating in the capital account may have its counterpart in the capital account. In this case, it does not change the country's net financial debit or credit position vis-à-vis the ROW.

Example: direct investment abroad financed by foreign currency borrowing.

• Investment transaction = ↗ assets abroad (export of capital = debit)
• Currency borrowing = ↗ liabilities to foreign countries (capital import = credit)

## Remarks

Importance de la balance de base (BB, aussi appelée balance des règlements officiels ou encore balance des comptes): dans les régimes de change fixe, elle indique la capacité de la Banque Centrale à honorer ses engagements, puisqu’un déficit de la balance de base signifie une baisse des réserves officielles.

H ne peut pas accuser simultanément F "d'envahir son marché intérieur" (CC < 0) et "de capturer toute son épargne" (${\displaystyle CF<0}$).

En principe : le solde agrégé de tous les CC sur le plan mondial devrait être égal à zéro. Or il est négatif! "Mystère du surplus manquant"

Quel est le niveau optimal de CC? Un déficit important et permanent crée des problèmes de crédibilité (détériore la position extérieure nette du pays, cf. cas des USA, le plus grand pays débiteur mondial, KO encadré 13.2). Un surplus important et permanent crée des tensions avec les partenaires commerciaux qui se plaignent de leurs déficits.

## To sum up

Wealth:

${\displaystyle total\ assets\ -total\ liabilities\ commitments}$

(amounts owned) - (amounts owing)

• Every time a nation saves, i.e. has a surplus in its current account, its wealth increases.
• Each time a nation borrows, i.e. runs a deficit in its current account, its wealth decreases.

External wealth (or external position) :

${\displaystyle total\ foreign\ assets\ held-total\ domestic\ assets\ held\ by\ foreigners}$
• A positive international investment position means that the country is in credit.
• A negative international investment position means that the country is in debit.

## Overall deficits and surpluses

In recent years, there are countries with very large surpluses (emerging countries + oil exporting countries) and countries with very large deficits (led by the USA + a number of developed countries).

Source: Feenstra and Taylor, 2008.

## Debtor and creditor countries

Source: Feenstra and Taylor, 2008.

The United States and other developed countries finance their current account deficits by selling securities that are purchased by countries that have trade surplus → change in ownership of securities → change in net holdings on the RDM

Capital flows from emerging to developed countries: not in line with the theory of intertemporal trade (see trade course).

The net position of a country also depends on changes in the value of assets.

Default risk: since 1980, 14 countries have not paid their debts due to foreign exchange crises → country risk ↑

## The case of Argentina

Source: Feenstra and Taylor, 2008.

Consequences of default: the country becomes less attractive for foreign investment and the country will have to pay higher interest rates.

Country risk: The additional interest rate that a country must pay to compensate investors for the risk of default. Example in June 2010, according to the Financial Times, compared to U.S. Treasury bills:

• Countries with "good ratings": Poland (A-): +1.88%, Mexico (BBB): +1.36%.
• Countries with junk-bond grades: Colombia (BB+): 2.16%, Turkey (BB+): +2.64%.
• Countries still considered as "technically in default": Argentina (grade D): +33%

## Partial correction?

Partial correction since 2009, Explanations?

Source: IMF, World Economic Outlook, 2011.

# Summary

A country's international investment position is frequently measured by the current account balance (CC) or the basic balance (BB).

In terms of macroeconomic aggregates, CC is equal to the difference between gross national income and domestic absorption (or expenditure).

CC is derived from the trade balance and the factor income balance. It reflects the external financing capacity (or need) of the country concerned.

The various items in the capital account (CK) and financial account (FC) indicate the materialisation of this financing capacity in terms of changes in assets held.

The balance of the BB indicates the capacity of the Central Bank to honour its commitments under a fixed exchange rate regime.

External imbalances have increased sharply since 2001.