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Balance of Payments

Capital & Financial


Accounts
Unit 15 - Lesson 2

Learning outcomes:
Explain the two components of the capital account, specifically capital
transfers and transactions in non- produced, non-financial assets.
Explain the three main components of the financial account,
specifically, direct investment, portfolio investment and reserve
assets.
Explain that the current account balance is equal to the sum of the
capital account and financial account balances.
Examine how the current account and the financial account are
interdependent.

Capital Account
Capital Transfers: debt forgiveness, money
given to a country to finance physical capital.
Inflows (Credits) - Outflows (Debits)
Non-Produced/Non-Financial Assets:
purchase or use of natural resources that
have not been produced.
Examples:Rights to Mineral, Forestry, Fishing
Balance of Capital Account
Sum of line 7 and 8

Tragakes, pg. 397

Financial Account
Consists of:
1. Direct Investment
2. Portfolio Investment
3. Reserve Assets
Balance of Financial Account
Sum of lines 9 + 10 + 11
Positive (+) - Inflows (Credits) > Outflows (Debits)
Negative (-) - Outflows (Debits) > Inflows (Credits)

Tragakes, pg. 396

Direct Investment
Direct Investment is Foreign Direct Investment
Investment in physical capital such as building and factories.
Direct Investment from foreigners (Credits) - Direct Investment abroad (Debit)
Positive (+) - Surplus - Inflows (Credits) > Outflows (Debits)
Negative (-) - Deficit - Outflows (Debits) > Inflows (Credits)

Portfolio Investment
Portfolio Investment: Investment in stocks & bonds
Borrowing from Foreign Lender - Inflows (Credits) in Portfolio Investment
Loans given to Foreign Countries - Outflows (Debits) in Portfolio Investment
Portfolio Investment = Inflows (Credits) - Outflows (Debits)
Note:
If a foreign company invests in Tanzania the result is an Inflow (Credit) to the
Financial Account; however, if the company takes profits out of Tanzania back
to the home country the result is an Outflow (Debit) to the Current Account.

Reserve Assets
Reserve Assets - Official Reserves
European Central Bank
If the ECB sells US ($) into the market and purchases Euros this
represents an Inflow (Credit) to the Financial Account.
If the ECB sells Euros into the market and purchases US ($) this
represents an Outflow (Debit) to the Financial Account.

Balance of Financial Account


Balance of the Financial Account = Direct + Portfolio + Reserve Assets
Balance of Financial Account:
Surplus - Positive (+) - Inflows (Credits) > Outflow (Debits)
Deficit - Negative (-) - Outflows (Debits) > Inflows (Credits)
Errors & Omissions
Due to the extreme difficulty of keeping track of all transactions
there many times exists an imbalance which is corrected using
Errors & Omissions

Balance of Payments
We know it consists of: Current Account, Capital Account & Financial Account
The sum of all three accounts will always equal zero - Credits = Debits.
Current Account Deficit - Excess Supply of Currency in Current
Account.
Surplus in Capital & Financial Accounts - Excess Demand of Currency
Current Account Surplus - Excess Demand of Currency in Current
Account.
Deficit in Capital and Financial Accounts - Excess Supply of Currency
Current Account + Capital Account + Financial Account = 0

Current Account - Deficit/Surplus


Current Account Deficit
Country consumes more than it produces - pays for the extra
output/consumption through the surplus in the Financial Account
Country is consuming at a point outside its Production Possibility Frontier
Current Account Surplus
Country consumes less than it produces - extra income generated by the
sale of the additional output relates to the Financial Account Deficit.
Country is consuming at a point within its Production Possibility Frontier.

Imbalance in the Balance of Payments


Balance of Payment Deficits
Deficit in the Current Account, Capital Account, & Financial Account
Outflows (Debits) > Inflows (Credits)
Balance of Payment Surplus
Surplus in the Current Account, Capital Account & Financial Account
Inflows (Credits) > Outflows (Debits)
Imbalance almost always occur in countries Balance of Payment; however, it
will always balance either through market forces or Government Intervention.
Central Bank Intervention through Supply/Demand of the currency

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