Do two-way financial flows often dwarf the net flows

Do global
current account imbalances still matter in a world of deep international financial
markets where gross two-way financial flows often dwarf the net flows measured
in the current account? Contrary to a complete markets or “consenting adults” view
of the world, large current account imbalances, while very possibly warranted
by fundamentals and welcome, can also signal elevated macroeconomic and
financial stresses, as was arguably the case in the mid-2000s. Furthermore, the
increasingly big valuation changes in countries’ net international investment
positions, while potentially important in risk allocation, cannot be relied upon
systematically to offset the changes in national wealth implied by the current account.
The same factors that dictate careful attention to global imbalances also
imply, however, that data on gross international financial flows and positions
are central to any assessment of financial stability risks. The balance sheet mismatches
of leveraged entities provide the most direct indicators of potential
instability, much more so than do global imbalances, though the imbalances may
well be a symptom that deeper financial threats are gathering.

Organization of the research

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The
present research paper is divided into five chapters. The first chapter
describes the problem, purpose and structure of this paper. In the second
chapter the Balance of payment is introduced. The subchapters 2.1 summarizes
the Balance of Payment in general context. The subchapters 2.2 to 2.4 describes
the different sections of Balance of Payment including Capital account,
Financial account and Current Account. 
And of Chapter 3  is the aim of
this section is to demonstrate the importance and different types of balances
of Current account is explained in brief. In point in subchapters 3.1 and 3.2,
the Surplus and Deficit balance are highlighted upon in detail. The point 3.3
and 3.4 provides a detail analysis of cause and effect of the different
balances and it importance for the economy in long and shot run. Finally,
Chapter 4 summarizes and presents the results of this research project.

Introduction to
Balance of Payments

The Balance of Payments is a Financial
Statement that methodically summarizes, all the economic transactions of an economy,
for a specific period,. The given transactions are mostly between governments
of different economy and between residents and non-residents1. The transactions include a
country’s individuals, companies and government bodies between other economies that
include individuals, companies and government bodies. These transactions
consist of imports and exports of goods, services and
capital, as well as transfer payments such as foreign aid and remittances
between these parties mention above.

Standard
Components of the Balance of Payments

Balance of Payments consist of current,
capital and financial accounts. Besides covering goods and services, Current
Account also covers income and current transfers and negative trade balance (or
trade deficit) is shown in Current Account, which in case the combined net
effect of trade balance, income and current transfers is also negative, the same
results as the Current
Account Deficit. The deficit needs to be financed by external borrowings and/or
investments which are constituents of Financial Accounts2.
The capital account records all of the external investment
transactions between a country and the rest of the world. It records capital transfers, Capital transfers are transactions that involve the
transfer of ownership of fixed assets; transfer of funds linked to, or
conditional upon and the acquisition and
disposal of nonfinancial and financial assets transactions
that result from both portfolio and direct investment3.

 

The Capital
Account Balance (CA)

The capital account
covers all transactions that involves the receipt or payment of capital
transfers and the acquisition or
disposal of non-produced, non-financial assets.  The capital account consists
of two categories: capital transfers and acquisition. Acquisition or disposal
of non-produced, nonfinancial assets consist of transactions related to
tangible assets that are play a very important part for production of goods and
services but are not actually produced (e.g., land and subsoil assets) and
transactions related with non-produced, intangible assets pay a very vial role
in production of goods or practice of certain services (e.g., patents,
copyrights, trademarks, franchises, etc. and leases or other transferable contracts).
However, in the case of resident/non-resident transactions in land (including
subsoil assets), all acquisition or disposal is deemed to occur between resident
and non-resident acquires a financial claim on a notional resident unit. The
only exception concerns land purchased or sold by a foreign personal is when
the purchase or sale involves a shift of the land from one economic territory
to another. In such instances, a transaction in land between residents and non-residents
is recorded under acquisition or disposal of non-produced, nonfinancial assets.

 

The Financial
Account Balance (FA)

The financial account records transactions in financial assets and
liabilities between residents and non-residents. It shows how an economy’s external
transactions are financed. Transactions recorded in the financial account are
classified by function (i.e. the purpose of the investment) into direct
investment, portfolio investment, financial derivatives, other investment and
reserve assets. The financial account measures , changes in domestic
ownership of foreign assets and foreign ownership of domestic assets. If foreign
ownership increases more than domestic ownership does, it creates a deficit in
the financial account. This means the country is selling off its assets, like gold, commodities and corporate stocks, faster than it is acquiring foreign assets.

 

 

 Current Account
Balance (CA)

The current account consists
of all economic transactions (other than those in financial assets and liabilities),
that occurs between resident and non-resident entities or between government of
different economy. It also includes offsets to current economic values provided
or acquired without something of economic value in exchange.  There
are four major components to the current account, i.e. goods; services; income such as investment income (compensation
of employees those involving transactions of real
resources) and current transfers like remittances, grants etc.
(those that are offsets to transactions provided or acquired
without a quid pro quo).4.

1 Balance of payments manual: by IMF- Fifth
Edition Page-6

2Balance
of payments manual: by IMF- Fifth Edition Page-37

 

4 Balance of payments manual: by IMF- Fifth
Edition Page-51 to 53

 

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