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2 if Tutorial QA

The document explains the balance of payments, focusing on the differences between the financial and current accounts, the net international investment position of South Africa, and the implications of current account surpluses and deficits. It discusses how direct foreign investment impacts both accounts over time and outlines the necessary changes in private savings, domestic investment, and government budget deficits to reduce a current account deficit. Overall, it emphasizes the relationship between a country's production and consumption of goods and services.

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6 views3 pages

2 if Tutorial QA

The document explains the balance of payments, focusing on the differences between the financial and current accounts, the net international investment position of South Africa, and the implications of current account surpluses and deficits. It discusses how direct foreign investment impacts both accounts over time and outlines the necessary changes in private savings, domestic investment, and government budget deficits to reduce a current account deficit. Overall, it emphasizes the relationship between a country's production and consumption of goods and services.

Uploaded by

nardhamunijarryd
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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International Finance Tutorials

2. Balance of payments

1/ What is the difference between the financial account and the current account?
The financial account in the balance of payments indicates the net asset transfers
between the home country and foreign countries during the time period under
consideration. A net debit balance (financial account deficit or net capital outflow)
indicates that home country wealthholders increased their holdings of foreign assets
relative to foreign wealthholders’ ownership of home country assets. A net credit
balance (financial account surplus or net capital inflow) indicates the opposite. The
current account reflects the net effect with respect to foreign countries of the sources
and uses of home country current income during the time period. A net debit balance
(current account deficit) indicates that current income used to purchase imports of
goods and services, to purchase foreign factor services, and to make unilateral
transfers abroad (secondary income paid) exceeded current income generated by
exports of goods and services, by exports of factor services, and by the receipt of
unilateral transfers from abroad (secondary income received). A net credit balance
(current account surplus) reflects the opposite.

2/ What is meant by the “net international investment position” of South Africa?


The “net international investment position” shows the total existing stock of foreign
assets (physical and financial) owned by SA citizens and government minus the total
existing stock of SA assets (physical and financial) owned by foreign citizens and
governments.

3/ China has had current account surpluses for many years, and sometimes these
surpluses have been larger than China’s balance on goods and services and
sometimes they have been smaller. Explain in balance-of-payments accounting terms
why this can be the case.
A country such as China can have a current account surplus that is larger than its
surplus on goods and services if the sum of its income receipts from Chinese factors
abroad (primary income received) and unilateral transfers received (secondary
income received) is larger than the sum of its payments of income to foreign factors
in China (primary income paid) and unilateral transfers made (secondary income
paid) during the given year. The current account surplus would be smaller than the
surplus on goods and services if the sum of primary and secondary income paid
exceeded the sum of primary and secondary income received during the given year.
4/ Explain why a current account deficit indicates that a country is using more goods
and services than it is producing.
Since Y = C + I + G + (X - M), the current account balance can be defined as (X - M) = Y
- (C + I + G). With a current account deficit, (X - M) < 0 or, therefore, Y < (C + I + G).
Because Y indicates production in the economy and (C + I + G) indicates total
spending by the country’s residents (or the use of goods and services), the fact that Y
< (C + I + G) means that the country’s use of goods and services is greater than the
country’s production.

5/ “Direct foreign investment affects both the financial account and current account
over time.” Agree? Disagree? Explain.
Agree. When the initial investment is made, say the purchase of a foreign production
facility by a Country A firm, there is both a debit in the financial account of country A
[“increase in private assets abroad (direct investment)”) and a credit in A’s financial
account [either an “increase in foreign private assets in country A (portfolio
investment)” if the foreign firm selling the facility is given a bank account in country
A, or a “decrease in A’s private assets abroad (portfolio investment)” if payment is
made from the A firm’s bank balance abroad]. Over time, A’s current account can be
affected in a variety of ways – for example, exports from A of components to the new
facility can take place, final goods imports into A from the facility can occur, and
profits may be repatriated to A. Of course, if A’s currency depreciates because of the
initial capital outflow, this can alter A’s current account immediately.

6/ Using equation (9) or (10) in the lecture slides, explain the change in private
savings, domestic investment and government budget deficit required to reduce the
current account deficit of a given country.
This equation tells us that to reduce the current account deficit, a country must
increase its private saving, and/or reduce domestic investment, and/or cut its
government budget deficit (or increase the budget surplus):
i) if domestic private savings (S) rises, ceteris paribus, then consumption falls
(fall in demand for domestically produced goods and imported goods) and so do
imports, resulting in an improvement in the current account;
ii) the government deficit can be reduced or the government budget surplus can
be improved by reducing government spending (on domestically and foreign
produced goods), reducing imports and improving the current account. Alternatively,
the government deficit can be reduced or the government budget surplus can be
improved by increasing taxes, thus increasing tax revenue, T, reducing disposable
income which in turn reduces demand for imports (and domestic goods) thus
improving the current account balance;
iii) a lower level of domestic investment, I, can be achieved by reducing the
demand for domestically produced and foreign produced investment goods, which
lowers imports and improves the current account.
In all cases, the improvement of the current account is at the expense of growth and
employment.

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