Description
international liquidity and various exchange rate regimes. It also explains what is balance of payments, current account, capital account and reserve account. It answers the question why disequilibrium arises and what are the strategies for correcting disequilibrium.
The International Monetary System & Balance of Payment
Definition
The International Monetary System facilitates transfer of funds between parties, conversion of national currencies into one another, acquisition and liquidation of financial assets, and international credit creation ( P G Apte ) The institutional framework within which international payments are made, movements of capital are accommodated and exchange arte among currencies are determined. It refers to the financial arrangements that exist to ensure that international business is carried out smoothly. ( Sathey )
INTERNATIONAL LIQUIDITY
• International trade & investment transactions have counter parties located in two different countries • Problems arise because financial instruments acceptable to both the parties may not be readily available • An example
– An Indian importer wants to import goods from South Korea – Importer is willing to pay in INR – Exporter may want to be paid in Won – One possible solution is that an Indian exporter exports goods to South Korea, earns Wons and provides them to the Indian importer – Another alternative could be to use a currency that is generally acceptable – such as the US dollar
• Such a currency must be available in sufficient quantity without any restrictions
INTERNATIONAL LIQUIDITY
• A good banking system is also necessary • Example
– Australian banks closing their regional branches
• Example
– What if Citibank & other international banks were to close their business in all Asian countries including correspondent banking !
• A generally acceptable currency available in sufficient quantity without restrictions and a good banking system are needed for IMS
INTERNATIONAL LIQUIDITY
• Solution 1 :
– Some currencies must be freely convertible into other currencies – There should be a market mechanism in place to ensure this – Example : British pound, US Dollar, Euro
• Solution 2 :
– Create an international paper currency – Example – SDR
Evolution of IMS
• Gold Standard ( 1875 – 1914 )
– Currency value to be fixed to a certain quantity of gold
• Bretton Woods Agreement ( 1945 – 1972 )
– Currency value to be fixed against USD which in turn was fixed against gold at $ 35 per ounce
• Smithsonian Agreement
– Devaluation of USD to $ 38 per ounce – Revaluation of other currencies by 10% – Band to widen from 1 % to 2.25 %
• Jamaica Agreement ( 1973 onwards )
– Currency free to float against other currencies with the market forces determining the exchange rate
EXCHANGE RATE REGIMES
The IMF classifies member countries into eight categories
• • • • • • • • Currency Union (No separate legal tender)(41) Currency Board Arrangement (7) Conventional Fixed Peg Arrangements (41) Pegged Exchange Rates within Horizontal Bands(5) Crawling Peg(6) Crawling bands (1) Managed float with no pre-announced path (51) Independent float (35)
Ex Rate Regime – RBI’s clarification
•
Source : RBI press release dated 21st July, 05
REVALUATION OF YUAN
• China last week ended its currency's decade-old peg to the U.S. dollar, allowing the yuan, also known as the renminbi, to strengthen 2.1 percent from its previously fixed rate of about 8.3, marking the first step toward a more flexible exchange rate regime. Under the new exchange rate mechanism, the yuan will be allowed to trade within a limit of 0.3 percent either side of the yuan-dollar exchange rate published by the People's Bank of China each day. The yuan will be allowed to trade within a 1.5 percent range either side of the rate published for other currencies. The exchange rate will use a basket of currencies, the composition of which has not been disclosed, as a reference. PBC declares a rate of 8.11 yuan to a dollar on 25th July, 05 Market price on 1st Sep, 06 was 7.9550 yuan to a $
•
• •
REVALUATION OF YUAN
• The Chinese called it a “managed floating exchangerate regime”, which may well imply more management than floating. Neither the currencies in the basket used to set the level of the yuan, nor their weights, have been disclosed. The fact that the Chinese have acted at all is important. But the eventual economic and political effects of the revaluation will depend on how far and how fast the yuan moves from now on. In Friday's trading it barely budged—and in fact closed a fraction below 8.11 to the dollar, suggesting the authorities are keen to damp down market expectations of further rises.
RELATED ARTICLES
• Converting Russia’s future in Financial Times published in Business Standard dated Saturday, 15th July, 06.
• Monetary Policy and Exchange Rate Frameworks: The Indian Experience by Rakesh Mohan, Dy. Governor, RBI at the Second High Level Seminar on Asian Financial Integration organised by the International Monetary Fund and Monetary Authority of Singapore in Singapore on May 25, 2006.
BALANCE OF PAYMENT
DEFINITION
• The balance of payment of a country is a systematic accounting record of all economic transactions during a given period of time between the residents of the country and residents of foreign country • “residents of foreign countries ” may often be replaced by “ non-residents” or “ rest of the world ”
Concepts
• Economic transaction entails transfer of economic value from one economic agent ( individual, business, Govt.) to other • A transfer is requited when the transferee gives something of economic value to the transferor in return • Unrequited transfer is a unilateral gift.
Concepts
• Real & Financial Transfer
• Purchase of goods with a promise to pay • Purchase or sale of goods in return for goods barter transaction • Purchase of a foreign security by issuing a cheque from an account abroad • A unilateral gift in kind. • A unilateral financial gift.
Concepts
• Residents – much more than citizens • Whose center of interest rests in the given economy & who carry out economic activities within territories of that country • Govt. & non-profit bodies ? • Branches of multinationals? • UN, World Bank, IMF ?
Rules
• All transactions leading to an immediate or prospective payment from ROW should be recorded as credit. The payments themselves are to be recorded as debit entries • Converse ? • A transaction which results in an increase in demand for foreign exchange is to be recorded as a debit entry while that which results in an increase in supply of foreign exchange is to be recorded as credit entry.
Examples ( current a/c )
• Merchandise :
– Exports, valued on f.o.b. basis, are credit entries – Imports, valued at c.I.f., are debit entries
• Invisibles :
– Receipt in fex received by an AD in India from organizers of foreign tourist parties are credit in “ travel “ – Freight charges paid to non-resident steamship company directly when imports are on f.o.b. terms appear as debit under “ transportation “ – Premiums of all kinds of insurance & re-insurance provided by Indian insurance companies to non-resident clients appear as credits under “ insurance “ – Interest paid by a resident company on foreign borrowing will appear as debit in “investment income ” – Cash remittance by Indian nationals residing abroad will be a credit entry in “ private transfers “
Examples ( capital a/c )
• Foreign equity investments
– FDI – Ford Motors starting a car plant in India – FII – purchase of stocks of Indian companies by foreign institutional investors
• Loans
– Disbursements received by Indian entities are credits and repayments or loans made by Indian entities are debits – External assistance – concessional loans received by Govt. or public sector bodies – Medium and long term loans from commercial capital markets in the form of loans, bonds etc. – Short term credits such as trade credits
• Banking Capital
– Increase in assets are debits and increase in liabilities are credits – Deposits from non-residents are shown separately
Examples : ( exercise 1 page 63 )
( Germany’s BoP )
• A German supermarket chain imports tea from Sri Lanka. Payment is made in EUR into the exporter’s account in Frankfurt.
– Debit in Merchandise A/C and Credit in Banking Capital
• A German bank makes a 1 million dollar loan to a Swedish firm who wants the proceeds to be credited to its dollar account with a bank in London.
– Debit in Loans by Germany and credit in Banking Capital
• An American tour operator arranges a conducted tour and sends a cheque for Euro 250,000.- to a German travel agent to meet the tourists’ local expenses
– Credit in Invisible ( Travel ) and Debit in Banking capital
The Three Accounts
• Current Account : includes imports and exports of goods and services • Capital Account : includes transactions leading to changes in foreign financial assets & liabilities of the country • Reserve Account : Though it also relates to financial assets & liabilities, it includes only “ reserve assets ”
– Assets which are acceptable as means of payment in international transactions & are held by and exchanged between monetary authorities of trading countries – Monetary gold, assets denominated in foreign currencies , SDRs and reserve positions in the IMF
Surplus & Deficit in BoP
• The terms can not refer to entire BoP since it must balance • They indicate the imbalance between subset of accounts included in the BoP • Policy intervention normally addresses the disequilibrium condition • An optimal way of grouping the accounts within the BoP should have capability of giving signal to the monetary authorities • Autonomous and Accommodating Transactions
Accounting Identity
• BC + ?R + BK + ? = 0
BC = Balance of Payment on current account ?R = change in official reserves BK = balance on capital account ? = statistical discrepancy
• Flexible & Fixed Exchange Rate Regimes
Disequlibrium in BoP
• If total purchases of goods, services & securities equals the total sales of these items, there would be an equilibrium. • Self-generating & self-liquidating relationship
– – – – – Cyclical Structural Seasonal Short-run Long-run Fundamental
Why disequilibrium arises ?
• • • • • • Seasonal variations Changing demand for imports & exports Business cycles Inflation External borrowings & capital flows Macro-economic factors
Strategies for correcting disequilibrium
• Deflation
– Dear money policy
• • • • • •
Changes in Trade Policies Export Promotion Import Substitution Exchange Controls Exchange Rate depreciation Asking others to revalue their currencies ?
Alternative Approach
• In macro economic national accounting terms the current account is a mirror image of the difference between domestic savings and domestic investments • If domestic savings exceed domestic investments, a surplus on current account will result • If domestic savings are insufficient to finance domestic investments, a deficit on current account would result
– Drawdown of reserves or by external borrowings
Convertibility
• Trade Account convertibility
• Current Account convertibility • Capital Account convertibility
– Taropore Committee
CAPITAL ACCOUNT TRANSACTIONS
• Transaction which alters the assets or liabilities outside India of a person resident in India • Transaction which alters assets or liabilities in India of a person resident outside India • Examples :
– Issue of a security by a resident – Borrowing and lending in foreign exchange – Deposits between persons resident in India and persons resident outside India
CURRENT ACCOUNT TRANSACTION
• Transaction other than a capital account transaction and includes
– Payments due in connection with foreign trade, business, services etc. – Payments due as interest on loans and on investments – Remittance for living expenses of parents, spouse & children residing abroad – Expenses in connection with foreign travel, education and medical care
• Certain Transactions are prohibited
– Gambling, lotteries etc.
Forex Reserves & BoP
Why are BOP Statistics Important ?
• BOP statement contains useful information for financial decision makers. • In the short run, BOP deficits or surpluses may have an immediate impact on the exchange rate • When exchange rates are market determined, BOP figures indicate excess demand or supply for the currency and the possible impact on the exchange rate • May signal a policy shift on the part of the monetary authorities of the country, unilaterally or in concert with its trading partners
Why are BOP Statistics Important ? (contd.)
• Movements in a countries reserves have implications for the stock of money and credit circulating in the economy • Central bank's purchases of foreign exchange in the market will add to the money supply and vice versa unless the central bank "sterilizes" the impact by compensatory actions such as open market sales or purchases • Intimately connected with the overall savinginvestment balance in a country's national accounts
Summary
• The balance of payments of a county records its economic transactions with the rest of the world using a well defined set of accounting conventions • The phrase balance of payments deficit or surplus normally refers to the balance between credits and debits on the current account
Summary (contd.)
• Corporate finance managers must monitor the BOP data being put out by government agencies on a regular basis because they have both short term and long term implications for a host of economic and financial variables affecting the fortunes of the company
Trends in India’s BoP
• Trade Account
• Current Account
– Role of invisibles
• Capital Account
doc_105137120.pptx
international liquidity and various exchange rate regimes. It also explains what is balance of payments, current account, capital account and reserve account. It answers the question why disequilibrium arises and what are the strategies for correcting disequilibrium.
The International Monetary System & Balance of Payment
Definition
The International Monetary System facilitates transfer of funds between parties, conversion of national currencies into one another, acquisition and liquidation of financial assets, and international credit creation ( P G Apte ) The institutional framework within which international payments are made, movements of capital are accommodated and exchange arte among currencies are determined. It refers to the financial arrangements that exist to ensure that international business is carried out smoothly. ( Sathey )
INTERNATIONAL LIQUIDITY
• International trade & investment transactions have counter parties located in two different countries • Problems arise because financial instruments acceptable to both the parties may not be readily available • An example
– An Indian importer wants to import goods from South Korea – Importer is willing to pay in INR – Exporter may want to be paid in Won – One possible solution is that an Indian exporter exports goods to South Korea, earns Wons and provides them to the Indian importer – Another alternative could be to use a currency that is generally acceptable – such as the US dollar
• Such a currency must be available in sufficient quantity without any restrictions
INTERNATIONAL LIQUIDITY
• A good banking system is also necessary • Example
– Australian banks closing their regional branches
• Example
– What if Citibank & other international banks were to close their business in all Asian countries including correspondent banking !
• A generally acceptable currency available in sufficient quantity without restrictions and a good banking system are needed for IMS
INTERNATIONAL LIQUIDITY
• Solution 1 :
– Some currencies must be freely convertible into other currencies – There should be a market mechanism in place to ensure this – Example : British pound, US Dollar, Euro
• Solution 2 :
– Create an international paper currency – Example – SDR
Evolution of IMS
• Gold Standard ( 1875 – 1914 )
– Currency value to be fixed to a certain quantity of gold
• Bretton Woods Agreement ( 1945 – 1972 )
– Currency value to be fixed against USD which in turn was fixed against gold at $ 35 per ounce
• Smithsonian Agreement
– Devaluation of USD to $ 38 per ounce – Revaluation of other currencies by 10% – Band to widen from 1 % to 2.25 %
• Jamaica Agreement ( 1973 onwards )
– Currency free to float against other currencies with the market forces determining the exchange rate
EXCHANGE RATE REGIMES
The IMF classifies member countries into eight categories
• • • • • • • • Currency Union (No separate legal tender)(41) Currency Board Arrangement (7) Conventional Fixed Peg Arrangements (41) Pegged Exchange Rates within Horizontal Bands(5) Crawling Peg(6) Crawling bands (1) Managed float with no pre-announced path (51) Independent float (35)
Ex Rate Regime – RBI’s clarification
•
Source : RBI press release dated 21st July, 05
REVALUATION OF YUAN
• China last week ended its currency's decade-old peg to the U.S. dollar, allowing the yuan, also known as the renminbi, to strengthen 2.1 percent from its previously fixed rate of about 8.3, marking the first step toward a more flexible exchange rate regime. Under the new exchange rate mechanism, the yuan will be allowed to trade within a limit of 0.3 percent either side of the yuan-dollar exchange rate published by the People's Bank of China each day. The yuan will be allowed to trade within a 1.5 percent range either side of the rate published for other currencies. The exchange rate will use a basket of currencies, the composition of which has not been disclosed, as a reference. PBC declares a rate of 8.11 yuan to a dollar on 25th July, 05 Market price on 1st Sep, 06 was 7.9550 yuan to a $
•
• •
REVALUATION OF YUAN
• The Chinese called it a “managed floating exchangerate regime”, which may well imply more management than floating. Neither the currencies in the basket used to set the level of the yuan, nor their weights, have been disclosed. The fact that the Chinese have acted at all is important. But the eventual economic and political effects of the revaluation will depend on how far and how fast the yuan moves from now on. In Friday's trading it barely budged—and in fact closed a fraction below 8.11 to the dollar, suggesting the authorities are keen to damp down market expectations of further rises.
RELATED ARTICLES
• Converting Russia’s future in Financial Times published in Business Standard dated Saturday, 15th July, 06.
• Monetary Policy and Exchange Rate Frameworks: The Indian Experience by Rakesh Mohan, Dy. Governor, RBI at the Second High Level Seminar on Asian Financial Integration organised by the International Monetary Fund and Monetary Authority of Singapore in Singapore on May 25, 2006.
BALANCE OF PAYMENT
DEFINITION
• The balance of payment of a country is a systematic accounting record of all economic transactions during a given period of time between the residents of the country and residents of foreign country • “residents of foreign countries ” may often be replaced by “ non-residents” or “ rest of the world ”
Concepts
• Economic transaction entails transfer of economic value from one economic agent ( individual, business, Govt.) to other • A transfer is requited when the transferee gives something of economic value to the transferor in return • Unrequited transfer is a unilateral gift.
Concepts
• Real & Financial Transfer
• Purchase of goods with a promise to pay • Purchase or sale of goods in return for goods barter transaction • Purchase of a foreign security by issuing a cheque from an account abroad • A unilateral gift in kind. • A unilateral financial gift.
Concepts
• Residents – much more than citizens • Whose center of interest rests in the given economy & who carry out economic activities within territories of that country • Govt. & non-profit bodies ? • Branches of multinationals? • UN, World Bank, IMF ?
Rules
• All transactions leading to an immediate or prospective payment from ROW should be recorded as credit. The payments themselves are to be recorded as debit entries • Converse ? • A transaction which results in an increase in demand for foreign exchange is to be recorded as a debit entry while that which results in an increase in supply of foreign exchange is to be recorded as credit entry.
Examples ( current a/c )
• Merchandise :
– Exports, valued on f.o.b. basis, are credit entries – Imports, valued at c.I.f., are debit entries
• Invisibles :
– Receipt in fex received by an AD in India from organizers of foreign tourist parties are credit in “ travel “ – Freight charges paid to non-resident steamship company directly when imports are on f.o.b. terms appear as debit under “ transportation “ – Premiums of all kinds of insurance & re-insurance provided by Indian insurance companies to non-resident clients appear as credits under “ insurance “ – Interest paid by a resident company on foreign borrowing will appear as debit in “investment income ” – Cash remittance by Indian nationals residing abroad will be a credit entry in “ private transfers “
Examples ( capital a/c )
• Foreign equity investments
– FDI – Ford Motors starting a car plant in India – FII – purchase of stocks of Indian companies by foreign institutional investors
• Loans
– Disbursements received by Indian entities are credits and repayments or loans made by Indian entities are debits – External assistance – concessional loans received by Govt. or public sector bodies – Medium and long term loans from commercial capital markets in the form of loans, bonds etc. – Short term credits such as trade credits
• Banking Capital
– Increase in assets are debits and increase in liabilities are credits – Deposits from non-residents are shown separately
Examples : ( exercise 1 page 63 )
( Germany’s BoP )
• A German supermarket chain imports tea from Sri Lanka. Payment is made in EUR into the exporter’s account in Frankfurt.
– Debit in Merchandise A/C and Credit in Banking Capital
• A German bank makes a 1 million dollar loan to a Swedish firm who wants the proceeds to be credited to its dollar account with a bank in London.
– Debit in Loans by Germany and credit in Banking Capital
• An American tour operator arranges a conducted tour and sends a cheque for Euro 250,000.- to a German travel agent to meet the tourists’ local expenses
– Credit in Invisible ( Travel ) and Debit in Banking capital
The Three Accounts
• Current Account : includes imports and exports of goods and services • Capital Account : includes transactions leading to changes in foreign financial assets & liabilities of the country • Reserve Account : Though it also relates to financial assets & liabilities, it includes only “ reserve assets ”
– Assets which are acceptable as means of payment in international transactions & are held by and exchanged between monetary authorities of trading countries – Monetary gold, assets denominated in foreign currencies , SDRs and reserve positions in the IMF
Surplus & Deficit in BoP
• The terms can not refer to entire BoP since it must balance • They indicate the imbalance between subset of accounts included in the BoP • Policy intervention normally addresses the disequilibrium condition • An optimal way of grouping the accounts within the BoP should have capability of giving signal to the monetary authorities • Autonomous and Accommodating Transactions
Accounting Identity
• BC + ?R + BK + ? = 0
BC = Balance of Payment on current account ?R = change in official reserves BK = balance on capital account ? = statistical discrepancy
• Flexible & Fixed Exchange Rate Regimes
Disequlibrium in BoP
• If total purchases of goods, services & securities equals the total sales of these items, there would be an equilibrium. • Self-generating & self-liquidating relationship
– – – – – Cyclical Structural Seasonal Short-run Long-run Fundamental
Why disequilibrium arises ?
• • • • • • Seasonal variations Changing demand for imports & exports Business cycles Inflation External borrowings & capital flows Macro-economic factors
Strategies for correcting disequilibrium
• Deflation
– Dear money policy
• • • • • •
Changes in Trade Policies Export Promotion Import Substitution Exchange Controls Exchange Rate depreciation Asking others to revalue their currencies ?
Alternative Approach
• In macro economic national accounting terms the current account is a mirror image of the difference between domestic savings and domestic investments • If domestic savings exceed domestic investments, a surplus on current account will result • If domestic savings are insufficient to finance domestic investments, a deficit on current account would result
– Drawdown of reserves or by external borrowings
Convertibility
• Trade Account convertibility
• Current Account convertibility • Capital Account convertibility
– Taropore Committee
CAPITAL ACCOUNT TRANSACTIONS
• Transaction which alters the assets or liabilities outside India of a person resident in India • Transaction which alters assets or liabilities in India of a person resident outside India • Examples :
– Issue of a security by a resident – Borrowing and lending in foreign exchange – Deposits between persons resident in India and persons resident outside India
CURRENT ACCOUNT TRANSACTION
• Transaction other than a capital account transaction and includes
– Payments due in connection with foreign trade, business, services etc. – Payments due as interest on loans and on investments – Remittance for living expenses of parents, spouse & children residing abroad – Expenses in connection with foreign travel, education and medical care
• Certain Transactions are prohibited
– Gambling, lotteries etc.
Forex Reserves & BoP
Why are BOP Statistics Important ?
• BOP statement contains useful information for financial decision makers. • In the short run, BOP deficits or surpluses may have an immediate impact on the exchange rate • When exchange rates are market determined, BOP figures indicate excess demand or supply for the currency and the possible impact on the exchange rate • May signal a policy shift on the part of the monetary authorities of the country, unilaterally or in concert with its trading partners
Why are BOP Statistics Important ? (contd.)
• Movements in a countries reserves have implications for the stock of money and credit circulating in the economy • Central bank's purchases of foreign exchange in the market will add to the money supply and vice versa unless the central bank "sterilizes" the impact by compensatory actions such as open market sales or purchases • Intimately connected with the overall savinginvestment balance in a country's national accounts
Summary
• The balance of payments of a county records its economic transactions with the rest of the world using a well defined set of accounting conventions • The phrase balance of payments deficit or surplus normally refers to the balance between credits and debits on the current account
Summary (contd.)
• Corporate finance managers must monitor the BOP data being put out by government agencies on a regular basis because they have both short term and long term implications for a host of economic and financial variables affecting the fortunes of the company
Trends in India’s BoP
• Trade Account
• Current Account
– Role of invisibles
• Capital Account
doc_105137120.pptx