The balance of payments, old structure
International trade is the total trade a country does with all other countries. Its balance of payments is the statement of its transactions with the rest of the world. In the traditional presentation it has two accounts. The current account holds transactions on revenue account: imports and exports of goods and services. The capital account holds capital flows: FDI, FII, loans, grants and the like.
Ideally the surplus or deficit on one account squares off the other, keeping the overall balance of payments in equilibrium. The syllabus adds, dryly, that this seldom happens.
The balance of payments, IMF BPM6 structure
The presentation now in vogue is the IMF's BPM6. The current account is almost unchanged in the nature of transactions it records. The capital account is narrowed to non-produced, non-financial assets such as patents, rights, land and natural resources, plus capital grants, donations and transfers. Everything that used to sit in the capital account moves to a financial account, which sits alongside the reserve account managed by the central bank. So FDI, portfolio investment, derivative transactions, long-term debt flows and reserve asset transactions are all recorded in the financial account.
Current account + Capital account + Financial account + Errors and omissions = Change in reserve asset position
- The change in reserve assets is either a drain on foreign exchange reserves or an increase in them.
Under the old structure FDI was a capital account item. Under BPM6 it is a financial account item, and the capital account is reserved for things like patents, land and capital grants. A question framed on BPM6 that puts FDI in the capital account is wrong.
A country running continuous current account deficits needs capital account surpluses to support them; otherwise it depletes its foreign currency reserves. In either case it risks losing the confidence of market participants, and its currency would depreciate sooner.
Globalisation
Globalisation, simply stated, is the ability of individuals and firms to produce anything anywhere and sell anything anywhere in the world. It also means resources, people and capital, flow to wherever they are used best and earn the best returns through value addition. In a stable phase of globalisation the world looks flatter, with fewer and fewer entry barriers, as economies conclude that a protective attitude will not take them far and open up to allocate resources for maximum output. Many countries, including developing ones, have embraced it; none is compelled to, and each decides on its own assessment of the advantages.
| Positives | Negatives | |
|---|---|---|
| Resources | Best allocation of global resources, which flow where they produce and earn best | Survival of the fittest: jobs move to the most competitive countries, leaving those with less competent talent without opportunities |
| Economies | Developing economies integrate with the developed world, learn, grow, and gain access to new products, services and technologies | Integration transmits trouble: the 2008 credit crisis in the US created havoc worldwide |
| Bargaining | Consumers gain from global competition, which drives creativity and innovation and keeps prices in check | Developed countries gain first, from experience with less developed partners and hard negotiation of trade agreements; developing countries need strong political will to protect their interests |
| Culture | Greater access to foreign art, movies, music, food and clothing: more choices | Age-old traditions can erode under a unified western culture unless citizens assert their originality; ESG compliance has shown such issues become commercial and business issues |
- International trade is a country's total trade with the rest of the world; the balance of payments records its transactions with the world. In the old structure the current account holds revenue transactions (imports and exports of goods and services) and the capital account holds capital flows (FDI, FII, loans, grants). Imports above exports is a current account deficit; inflows above outflows is a capital account surplus; the two are meant to square off but seldom do.
- Under the IMF BPM6 structure the current account is unchanged, the capital account holds non-produced non-financial assets (patents, rights, land, natural resources) and capital grants and transfers, and a new financial account holds FDI, portfolio investment, derivatives, long-term debt flows and reserve asset transactions with the central bank's reserve account. Current plus capital plus financial plus errors and omissions equals the change in reserve assets.
- Continuous current account deficits need capital surpluses or they drain forex reserves; either way confidence erodes and the currency depreciates sooner.
- Globalisation is producing anything anywhere and selling anything anywhere, with resources flowing where they earn best. Positives: best allocation of resources, integration and learning for developing economies, consumer benefits from competition, access to foreign culture. Negatives: survival of the fittest for jobs, contagion (the 2008 US credit crisis), initial advantage to developed countries in negotiations, and cultural erosion, which ESG has shown becomes a commercial issue.