Multinational Financial Management Alan Shapiro 7th Edition J.Wiley & Sons Power Points by Joseph F Greco, Ph.D California State University, Fullerton CHAPTER THE BALANCE OF PAYMENTS AND INTERNATIONAL LINKAGES CHAPTER OVERVIEW I BALANCE-OF-PAYMENT CATEGORIES II THE INTERNATIONAL FLOW OF GOODS, SERVICES,AND CAPITAL III COPING WITH CURRENT ACCOUNT DEFICITS PART I BALANCE-OF-PAYMENT CATEGORIES A THE BALANCE OF PAYMENTS (B-O-P) PURPOSE: Measures all financial and economic transactions over a specified period of time BALANCE-OF-PAYMENT CATEGORIES Double-entry bookkeeping a Currency inflows = credits earn foreign exchange b Currency outflows = debits expend foreign exchange BALANCE-OF-PAYMENT CATEGORIES Three Major Accounts: a Current b Capital c Official Reserves Current Account records net flow of goods, services, and unilateral transfers BALANCE-OF-PAYMENT CATEGORIES Capital Account a Function: records public and private investment and lending b Inflows = credits c Outflows = debits BALANCE-OF-PAYMENT CATEGORIES Capital Account (con’t) d Transactions classified as 1.) portfolio 2.) direct 3.) short term BALANCE-OF-PAYMENT CATEGORIES Official Reserves Account a Function: 1.) measures changes in international reserves owned by central banks 2.) reflects surplus/deficit of a.) current account b.) capital account BALANCE-OF-PAYMENT CATEGORIES Official Reserves Account (con’t) b Reserves consist of 1.) gold 2.) convertible securities 10 THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL C THE LINK BETWEEN THE CURRENT AND CAPITAL ACCOUNTS Beginning identity NI - NS = X - M (5.4) where X = exports M = imports X-M=current account balance (CA) 23 THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL Combining (5.3) + (5.4) S - I = X - M (5.5) If S - I = Net Foreign Investment (NFI) NFI = X - M (5.6) 24 THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL Implications: a If CA is in surplus, the nation must be a net exporter of capital b If CA is a deficit, the nation is a major capital importer c When NS > NI, the excess must be acquired through foreign trade 25 THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL d Solutions for Improving CA deficits: 1.) Raise national income (output) relative to domestic investment (I) 2.) Increase (S) relative to domestic investment (I) 26 THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL D GOVERNMENT BUDGETS AND CURRENT ACCOUNT DEFICITS CURRENT ACCOUNT BALANCE CA = Saving Surplus - Gov’t budget deficit 27 THE INTERNATIONAL FLOW OF GOODS, SERVICES, AND CAPITAL CA Deficit means the nation is not saving enough to finance (I) and the deficit CA Surplus means the nation is saving more than needed to finance its (I) and deficit 28 PART III COPING WITH THE CURRENT ACCOUNT DEFICIT I POSSIBLE SOLUTIONS UNLIKELY TO WORK: A Currency Depreciation B Protectionism 29 COPING WITH THE CURRENT ACCOUNT DEFICIT II.CURRENCY DEPRECIATION A U.S Experience: Does not improve the trade deficit 30 COPING WITH THE CURRENT ACCOUNT DEFICIT B Depreciations are ineffective because It takes time to affect trade J-Curve Effect states that a decline in currency value will initially worsen the deficit before improvement 31 THE J - CURVE Net change in trade balance Trade balance improves Currency depreciation TIME Trade balance initially deteriorates 32 COPING WITH THE CURRENT ACCOUNT DEFICIT III PROTECTIONISM A Trade Barriers used: Tariffs Quotas B Results: Most likely will reduce both X and M 33 COPING WITH THE CURRENT ACCOUNT DEFICIT C FOREIGN OWNERSHIP one protectionist solution would place limits on or eliminate foreign ownership leading to capital inflows 34 COPING WITH THE CURRENT ACCOUNT DEFICIT D STIMULATE NATIONAL SAVING change the tax regulations and rates 35 COPING WITH THE CURRENT ACCOUNT DEFICIT III SUMMARY: CURRENT-ACCOUNT DEFICITS - neither bad nor good inherently Since one country’s exports are another’s imports, it is not possible for all to run a surplus 36 COPING WITH THE CURRENT ACCOUNT DEFICIT Deficits may be a solution to the problem of different national propensities to save and invest 37 ... DEFICITS PART I BALANCE-OF-PAYMENT CATEGORIES A THE BALANCE OF PAYMENTS (B-O-P) PURPOSE: Measures all financial and economic transactions over a specified period of time BALANCE-OF-PAYMENT CATEGORIES