Components of The Balance Of Payments (DP IB Economics)

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Steve Vorster

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:

  1. 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 immigrate

  2. Transactions 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

  1. 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 (-)
     

  2. 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 (-)
     

  3. 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 (-)
     

  4. 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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Steve Vorster

Author: Steve Vorster

Expertise: Economics & Business Subject Lead

Steve has taught A Level, GCSE, IGCSE Business and Economics - as well as IBDP Economics and Business Management. He is an IBDP Examiner and IGCSE textbook author. His students regularly achieve 90-100% in their final exams. Steve has been the Assistant Head of Sixth Form for a school in Devon, and Head of Economics at the world's largest International school in Singapore. He loves to create resources which speed up student learning and are easily accessible by all.

Jenna Quinn

Author: Jenna Quinn

Expertise: Head of New Subjects

Jenna studied at Cardiff University before training to become a science teacher at the University of Bath specialising in Biology (although she loves teaching all three sciences at GCSE level!). Teaching is her passion, and with 10 years experience teaching across a wide range of specifications – from GCSE and A Level Biology in the UK to IGCSE and IB Biology internationally – she knows what is required to pass those Biology exams.