Components of The Balance Of Payments (DP IB Economics)
Revision Note
Written by: Steve Vorster
Reviewed by: Jenna Quinn
An Introduction to the Balance of Payments
The Balance of Payments (BoP) for a country is a record of all the financial transactions that occur between it and the rest of the world
The BoP has two main sections:
The current account: all transactions related to goods/services along with payments related to the transfer of income
The financial and capital account: all transactions related to savings, investment and currency stabilisation
Money flowing into an account is recorded in the relevant account as a credit (+) and money flowing out as a debit (-)
If more money flows into an account than out of it, there is a surplus in the account
If more money flows out of an account than into it, there is a deficit in the account
The Current Account
The Current Account is often considered to be the most important account in the BoP
This account records the net income that an economy gains from international transactions
An Example of the UK Current Account Balance for 2017
Component | 2017 |
Balance of trade in goods (exports - imports) | £-32.9bn |
Balance of trade in services (exports - imports) | £27.9bn |
Sub-total trade in goods/services | £-5bn |
Net income (interest, profits and dividends) | £-2.1bn |
Current transfers | £-3.6bn |
Total Current Account Balance | £-10.7bn |
Current Account as a % of GDP | 3.7% |
Goods are also referred to as visible exports/imports
Services are also referred to as invisible exports/imports
Net income consists of income transfers by citizens and corporations
Credits are received from UK citizens who are abroad and send remittances home
Debits are sent by foreigners working in the UK back to their countries
Current transfers are typically payments at government level between countries e.g. contributions to the World Bank
The Capital Account
The Capital Account records small capital flows between countries and is relatively inconsequential
The capital account is made up of two sections:
Capital transfers
Smaller flows of money between countries
E.g. Debt forgiveness payments by the government toward developing countries
E.g. Capital transfers by migrants as they emigrate and immigrateTransactions in non-produced, non-financial assets
Small payments are usually associated with royalties or copyright e.g. royalty payments by record labels to foreign artists
The Financial Account
The Financial Account records the flow of all transactions associated with changes of ownership of the country’s foreign financial assets and liabilities
It includes the following sub-sections
Foreign Direct Investment (FDI)
Flows of money to purchase a controlling interest (10% or more) in a foreign firm. Money flowing in is recorded as a credit (+) and money flowing out is a debit (-)
Portfolio Investment
Flows of money to purchase foreign company shares and debt securities (government and corporate bonds). Money flowing in is recorded as a credit (+) and money flowing out is a debit (-)
Official Borrowing
Government borrowing from other countries or institutions outside of their own economy e.g. loans from the International Monetary Fund (IMF) or foreign banks. When the money is received, it is recorded as a credit (+) and when the money (or interest payments) are repaid, it is recorded as a debit (-)
Reserve Assets
These are assets controlled by the Central Bank and available for use in achieving the goals of monetary policy. They include gold, foreign currency positions at the International Monetary Fund (IMF) and foreign exchange held by the Central Bank (USD, Euros etc.)
Interdependence Between the Accounts
It is called the BoP as the current account should balance with the capital and financial account and be equal to zero
If the current account balance is positive, then the capital/financial account balance is negative (and vice versa)
In reality, it never balances perfectly and the difference is called 'net error and omissions'
If there is a current account deficit, there must be a surplus in the capital and financial account
The excess spending on imports (current account deficit) has to be financed from money flowing into the country from the sale of assets (financial account surplus)
If there is a current account surplus, there must be a deficit in the capital and financial account
The excess income from exports (current account surplus) is financing the purchase of assets (financial account deficit) in other countries
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