BALANCE OF PAYMENTS

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Balance of Payments
Countries,

like businesses, need to

keep a record of all economic
transactions that occur.
By combining all of the separate
records into a single report, an idea
can be formed as to the state of the
economy.
In many countries, this report is
known as the Balance of Payments.
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Balance of Payments
A countrys

balance of payments is a
summary of all economic transactions that
occur between domestic entities and foreign
entities.
Entities includes households, firms and the
government.
The balance of payments is measured over
a given time period, usually one year.

Economic Transactions
The

economic transactions included in

a balance of payments include:
- the sale or purchase of physical
goods (e.g. computers)
- services (e.g. tourism )
- transactions involving real or
financial assets (e.g. investments)
- transfer payments (e.g. foreign aid)

Debits and Credits

An

example of a debit transaction for

Country X would be the purchase of
new military equipment from Country Y
- money has flowed out of Country Xs
economy to a foreign entity.
An example of a credit transaction
would be the purchase of wool from
Country X exporter - money has been
injected into Country Xs economy from
a foreign entity.
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Account Types
There

are many separate accounts which

make up the balance of payments.
These separate accounts come under four
main headings:
- the current account
- the capital account
- the financial account
- net errors and omissions
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The Current Account

The

current account contains several key

accounts, including:
- the merchandise trade
account
- the services account
- income account
- transfer account

Merchandise Trade Account

This

account records all transactions involving

physical goods, e.g. televisions, cars and food.

Exports

of a countrys goods are recorded as a

credit in the balance of payments.

Imports

of foreign goods are recorded as

debits in the balance of payments.

The

net merchandise trade balance is the total

value of all goods exported minus the total
value of all goods imported into a country.
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Services Account
This

account records all transactions involving

services rendered, such as tourism, banking
and legal consultation.

Services

performed by residents to foreigners

are a credit on the balance of payments.

Services

performed by foreigners for residents

are debits on the balance of payments.

The

services balance is the total value of

services performed by residents minus the
value of services performed by foreigners.
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Balance of Goods and Services

(Trade Balance)

The

trade balance combines the merchandise

trade and services accounts.
Thus, the trade balance is simply the total value
of all goods and services exported by a country
minus the total value of all goods and services
imported by into a country.

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Income Account
This

account records all income earned such

as wages, salaries and profits.
Income earned by residents from foreigners
is a credit on the balance of payments.
Income paid to foreigners by residents are
debits on the balance of payments.
The income balance is the total value of all
income earned by residents from foreigners
minus the total value of all income paid to
foreigners by residents.
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Transfers Account
This

account records all transfers such as

foreign aid and donations.
Transfers paid by residents to foreigners is a
credit on the balance of payments.
Transfers paid to residents from foreigners
are debits on the balance of payments.
The transfers balance is the total value of all
transfers received by residents from
foreigners minus the total value of all
transfers paid to foreigners by residents.
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Current Account Balance

The

current account balance is the total value of

a countrys balance on goods and services, net
income and net transfers.
When the balance is negative it is called a
current account deficit - more money flowed out
(leakage) than was injected into the economy.
When the balance is positive it is called a current
account surplus - more money was injected than
was spent overseas by residents.
When the balance is zero it is called a balanced
current account.
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Capital and Financial Accounts

These

accounts record all of the

physical capital and financial
transactions such as shares and
bonds.
Transactions where residents receive
money from foreigners is recorded as a
credit in the balance of payments (e.g.
foreign investment ).
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Capital and Financial Accounts

Transactions

where
residents pay money to
foreigners is recorded
as a debit in the
balance of payments
(e.g. profits paid to
foreign creditors).

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Capital and Financial Accounts

The

capital account records all

capital transactions (eg.
Migrants funds) and any
transactions of non-produced,
non-financial assets (eg.
Copyrights and patents).

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Capital and Financial Accounts

The financial account records all

transactions associated with changes of
ownership of a countrys foreign financial
assets and liabilities.
These include foreign investment
in a country or investments
made abroad by residents,
as well as transactions made
by monetary authorities (ie. Central
Banks or Federal Reserve Banks) in
assets such as monetary gold and foreign
exchange.
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Net Errors and Omissions

The

double entry bookkeeping system requires

that the debits must equal the credits in the
balance of payments.
If this is not the case, a residual account called
net errors and omissions will offset the
difference to ensure that the balance of
payments is, in fact, balanced.

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Current Account Deficits

Many

countries have their current accounts in

deficit.
This means more money has flowed out of
these economies than has been injected into
them.
If the trend continues it could be problematic
the economy could start to shrink with
foreign investors taking profits out of the
country and the Government could be forced
to either borrow money or to sell assets to
pay off the growing foreign debt.
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Current Account Deficits

If

the debt is private, however, it is up to the individual

borrowers to pay back the foreign debt, not the Government.

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