Global Economics – Balance of Payments
What is “Global Economics – Balance of Payments”?
The Balance of Payments (BOP) is a record of all the economic transactions (stated in the domestic currency) that takes place between a country and the rest of the world. This is effectively between residents of the domestic economy and the rest of the world in a specific period of time, usually a quarter or a year. These economic transactions include trade (i.e. export and import) in goods and services, income (labor and investment income), unilateral transfers, international capital flows (capital inflow and capital outflow), and official transactions of the country’s central bank and government with other central banks and governments.
Key Learning Points
- The BOP accounts are recorded within the principles of double-entry bookkeeping
- The three components of a country’s BOP are the current account, capital account, and the financial account
- The current account may be in surplus or deficit, but the BOP of a country should equal zero
Balance of Payments – Accounting
Just as in corporate accounting, in BOP accounts, there are inflows of money which are recorded as credit, and outflows of money, recorded as a debit. Credits include the value of exports, income received from investments made abroad, and an increase in liabilities or a decrease in assets. Debits included the value of imports, income paid out on inward foreign investments from other countries into that country, and increases in assets or decreases in liabilities.
The sum of both sides (debit and credit side) of the balance of payments accounts of a country should always be equal. However, there is no bookkeeping rule that the sums of individual sub-categories within each side have to be equal.
Each transaction in the balance of payments accounts is recorded in the principles of double-entry book-keeping i.e. there is an equal amount involved on each side of the equation. For example, if someone in the US purchases a Chinese product imported from China, the purchase is recorded as a debit or outflow to the US balance of payments account and recorded as a credit or inflow into the Chinese balance of payments account.
On the other hand, if a Brazilian company sends interest payment on a loan to a bank in the US, the transaction is recorded as a debit (outflow) in Brazil’s BOP account and a credit to the US account, as it’s an inflow of payment to this country’s account.
Balance of Payments – Components
The BOP of a country is basically broken into three different categories – the current account, capital account, and financial account.
Current Account: this records the trade in goods and services that a country has with other trading partner countries. The current account includes the following sub-components: merchandise trade and services, income and transfers. Consequently, the current account balance (CAB) of a country consists of net exports (i.e. trade in goods and services – also called the ‘Trade Balance’) + income (labor and investment income) + unilateral transfers.
Capital Account: this captures or records the flows (inflows and outflows) related to the purchase or sale of non-financial assets that are primarily used for production. Its sub-categories are capital transfers, and sales and purchases of non-financial assets.
Financial Account: this records the money flows for financial assets such as stocks and bonds. Basically, this account captures the money flows with reference to assets owned by a country (domestic) abroad and foreign-owned assets in that particular country. For example, U.S.-owned assets abroad and foreign-owned assets in the U.S.
In theory, these accounts should balance i.e. the sum of the payments for each account should be offset by the other two and vice-versa.
Balance of Payments – Example
Given below is an example of a country’s balance of payments. The subcategories of the current and financial accounts are also given, along with the capital account. From the information given below, we can see that these accounts balance.
The current account has a deficit here of $2,300. If we add up the capital account ($281) and the financial account (-$2,611) we see the offset here (i.e. $281 – $2,611 = – $2,300).
The current account can be in surplus or deficit, but the balance of payments should always be zero (which is the case here). Therefore, the current account on one side here, and the capital and the financial account on the other should balance each other out.