Balance of Payments

28 November 2019 by Tejvan Pettinger

The Balance of Payments is a record of a country’s transactions with the rest
of the world. It shows the receipts from trade. It consists of the current and
financial account

UK current account 1955-2015

1. Current account
This is a record of all payments for trade in goods and services plus income
flow it is divided into four parts.

 Balance of trade in goods (visibles)

 Balance of trade in services (invisibles) e.g. tourism, insurance.
 Net income flows. Primary income flows (wages and investment
income)
 Net current transfers. Secondary income flows (e.g. government
transfers to UN, EU)
2. Financial account
This is a record of all transactions for financial investment. It includes:
  Direct investment. This is net investment from abroad. For example, if a
UK firm built a factory in Japan it would be a debit item on UK financial
account)
 Portfolio investment. These are financial flows, such as the purchase of
bonds, gilts or saving in banks. They include
 short-term monetary flows known as “hot money flows” to
take advantage of exchange rate changes, e.g. foreign investor saving
money in a UK bank to take advantage of better interest rates – will be
a credit item on financial account
3. Capital Account
This refers to the transfer of funds associated with buying fixed assets such as
land

4. Balancing Item

In practice when the statistics are compiled there are likely to be errors,
therefore, the balancing item allows for these statistical discrepancies.

 (note the Financial Account used to be called the Capital Account,

which is potentially quite confusing. Even now some people refer to
financial account as the capital account)
Balance of payments equilibrium
  In a floating exchange rate the supply of currency will always equal the
demand for currency, and the balance of payments is zero.
 Therefore if there is a deficit on the current account there will be a
surplus on the financial/capital account.
 If there was an increase in interest rates this would cause hot money
flows to enter the UK, therefore there would be a surplus on the
financial account
The appreciation in the exchange rate would make exports less competitive
and imports more competitive therefore with fewer exports and more imports
there would be a deficit on the current account.

Factors affecting the balance of payments

A current account deficit could be caused by factors such as.

1. The rate of consumer spending on imports. For example, during an

economic boom, there will be increased spending and this will cause a
deficit on the current account.
2. International competitiveness. If a country experiences higher
inflation than its competitors, exports will be less competitive leading to
lower demand.
3. Exchange rate. If the exchange rate is overvalued, it makes exports
relatively more expensive leading to a deterioration in the current
account.
4. Structure of economy – deindustrialisation can harm the export sector.
 Factors affecting current account deficit
Should we be concerned about a current account deficit?

See more detail at – should we be concerned by current account deficit?

Cyclical nature of the current account
In the UK, a current account deficit often increases after a period of economic
growth. Higher economic growth leads to higher consumer spending and
therefore more spending on imports.

In an economic downturn, spending on imports usually declines leading to a

smaller current account deficit.

Balance of Payments
The BoP or balance of payments records the undertakings or transactions of
commodities, assets, and services between the citizens of a nation with the rest of
the world for a stated time frame frequently every year. There are two main accounts
in the BoP.

 Current account
 Capital account
Meaning
 The balance of payment is a systematic record of all the economic/monetary transactions
between the residents (all the units) of a country and the rest of the world in an
accounting year.
 It is prepared on the principles of the double-entry system.

Current Account Definition

The current account is a record of businesses in commodities, transfer payments,
and services. Trade-in commodities comprise the exports and imports of
commodities. Trade-in services comprise factor income and non-factor income
transactions or undertakings.

Transfer payments are the receipts that the citizens of a nation get for free’, without
having to provide any commodities or services in return. They consist of remittances,
grants, and gifts. They could be provided by the government or by private residents
living abroad.

Capital Account Definition

The capital account records all the international undertakings of assets. An asset is
any one of the types in which wealth can be held. For instance, stocks, bonds,
government debt, money, etc. The purchase of assets is a debit on the capital
account. If an Indian purchases a UK car company, it enters the capital account
undertakings as a debit (as foreign exchange is going out of India).

On the other hand, the sale of assets, like the sale of the share of an Indian
company to a Japanese customer, is a credit on the capital account. These items are
foreign direct investments (FDIs), foreign institutional investments (FIIs), assistance,
and external borrowings.

1 MARK QUESTIONS

Q 1. What is the balance of payment account of a country record?

Answer:

The balance of payment account records all the economic/monetary transactions between the
residents (all the units) of a country and the rest of the world in an accounting year.

Q2. What are the two components of the balance of payment account?

Answer:

(i) Current account

(ii) Capital account

Q 3. What is the balance of payment also known as??

Answer:

Balance of international payments

Q 4. What are economic transactions?

Answer:

Economic transactions refer to the transactions that involve money and the transfer of the
ownership of goods, services, assets, etc.

Q 5. Define current account..

Answer:

It is the part of the BOP that includes the exports and imports of goods and services, unilateral
transfers, and factor incomes to and from abroad.

Q 6. State the components of the current account.

Answer:

Components of current account are:

a) Import and export of goods

b) Import and export of services

c) Unilateral transfers

d) Factor incomes (COE, interest, dividend, etc.)