Impact of FDI on Balance of Payments

Very Hard International Economics Balance Of Payments

The balance of payments (BOP) is a comprehensive accounting of a country's economic transactions with the rest of the world over a specific time period. It consists of two primary accounts: the current account, which records trade in goods and services, and the capital and financial account, which logs capital transfers and financial transactions.

In considering the effects of a significant increase in foreign direct investment (FDI) inflows on a developing country’s balance of payments, it's crucial to examine the implications for both the current and capital accounts. Assume that this FDI inflow leads to substantial purchases of domestic assets by foreign entities.

Which of the following statements accurately describes the impact of this situation on the developing country's balance of payments?

The current account will improve due to increased foreign investment income but will reflect a deficit due to increased imports.

The capital account will show a surplus due to net inflows from FDI, and the current account may initially remain unchanged.

Both the current account and the capital account will deteriorate due to increased capital outflows resulting from profit repatriation.

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