In balance sheet mismatches of leveraged entities provide

In the resent
years one question had be asked very frequently, Does the current account imbalances
matter? And if yes, then what impacts does the imbalances have in the economy? Or
how does comparison between a global size of IFM where financial flows are so
huge that they dominate the current account of an individual economy? On the contrary
to a complete market 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 short 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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