Balance of payments

CONTENTS
The balance of payments
The current account
Financial and capital account
Current account deficit
Causes of a current account deficit
Consequences of a current account deficit
Causes of a current account surplus
Impact of a current account surplus
Terms of trade
Causes of changes in the terms of trade
 The balance of payments

A country’s balance of payments is a record of all the economic transactions between

residents of that country and residents in other countries.

Money coming into the country creates credit items, which have a positive sign.

Money going out of the country gives rise to debit items which have a negative sign.

The components of the balance of payments are

The current account

The capital account

The financial account

Equilibrium in the balance of payments

A balance of payments is in equilibrium if, over a period of years, the exchange rate
remains stable and autonomous credits and debits are equal in value (the annual
trade in goods and services is in overall balance).

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 The current account
The current account balance is the overall balance of the trade in goods, trade in services,
income and current transfers.

Current account transactions are subdivided into four parts:

Trade in goods:

The visible trade balance is a record of the export and import of physical goods. It is also known
as the balance of trade in goods.

Examples
raw materials
semi-manufactured products
manufactured goods.

Trade in services:

The invisible trade balance is a record of the export and import of services (intangible products).

Examples
shipping
tourism
banking
insurance.

Income:

Income is divided into two parts:

Income from employment of residents by overseas firms
Income from capital investment overseas

Current transfers:

Examples
money spent on foreign aid
money sent home by people working abroad
taxes received by the government from foreign residents and firms
bank deposits held in overseas banks.

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 Financial and capital account

Capital account

The capital account includes, for instance, government debt forgiveness,

money brought into and taken out of the country by migrants, the sales and
purchases of copyrights, patents and trademarks

Financial account

The financial account records large movements of funds into and out of the
country.

The balance on the financial account is made up of flows of capital to and from
the non-government sector, such as

direct investment in overseas facilities

portfolio investment (in shares, bonds, and so on)
speculative flows of currency

Movements on government foreign currency reserves are also included under

this heading.

Balancing item

The balance of payments as a whole must always balance. This is because any
credit item has to be matched by a corresponding debit item.

In practice, however, with so many transactions involved, it is difficult to keep

an accurate record. Some mistakes are likely to be made and some
transactions may not be included. To compensate for this, a net errors and
omissions figure (also sometimes called the balancing item) is included.

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