What is the Balance of Payments (BOP)?
The balance of payments (BOP) is the method countries use to monitor all international monetary transactions at a specific period. Usually, the BOP is calculated every quarter and every calendar year. All trades conducted by both the private and public sectors are accounted for in the BOP to determine how much money is going in and out of a country. If a country has received money, this is known as a credit, and if a country has paid or given money, the transaction is counted as a debit.
Theoretically, the BOP should be zero, meaning that assets (credits) and liabilities (debits) should balance, but in practice, this is rarely the case. Thus, the BOP can tell the observer if a country has a deficit or a surplus and from which part of the economy the discrepancies are stemming.
The balance of payments (BOP) is an accounting of a country’s international transactions for a particular time period.
Any transaction that causes money to flow into a country is a credit to its BOP account, and any transaction that causes money to flow out is a debit.
The BOP includes the current account, which mainly measures the flows of goods and services; the capital account, which consists of capital transfers and the acquisition and disposal of non-produced, non-financial assets; and the financial account, which records investment flows.
What does the Balance of Payments Mean?
The Balance of Payments report shows the current status of one country transactions with the rest of the world. The Balance of Payments is mainly divided in three accounts:
- Current Account;
- Capital Account;
- Financial Account.
The current account deals with economic input associated with the sale of goods and services (trough exports) plus income coming in; and economic output coming from the purchase of goods or services outside the country (trough imports) plus income paid to outsiders. The net result between inputs and outputs is called trade balance. A positive trade balance means exports are higher than imports and a deficit means the opposite.
On the other hand, the capital account deals with transfers of ownership of different type of assets (mostly physicals, as land or machinery) and other non-productive transfers of rights or assets that are not related to a current ongoing productive activity. Finally, the financial account deals with the flow of financial assets; this means, changes in ownership of domestic and foreign financial assets. The Balance of Payments is recorded according to standard bookkeeping procedures but in practice is rarely balanced, since the complexity of the transactions involved often create a disparity between the accounts. This disparity is normally transferred to the country’s financial reserves either if it is a positive or a negative difference.
The balance of payments (BOP), also known as balance of international payments, summarizes all transactions that a country’s individuals, companies, and government bodies complete with individuals, companies, and government bodies outside the country. These transactions consist of imports and exports of goods, services, and capital, as well as transfer payments, such as foreign aid and remittances.
A country’s balance of payments and its net international investment position together constitute its international accounts.
The Current Account
The current account is used to mark the inflow and outflow of goods and services into a country. Earnings on investments, both public and private, are also put into the current account.
Within the current account are credits and debits on the trade of merchandise, which includes goods such as raw materials and manufactured goods that are bought, sold, or given away (possibly in the form of aid). Services refer to receipts from tourism, transportation (like the levy that must be paid in Egypt when a ship passes through the Suez Canal), engineering, business service fees (from lawyers or management consulting, for example), and royalties from patents and copyrights. When combined, goods and services together make up a country’s balance of trade (BOT). The BOT is typically the biggest bulk of a country’s balance of payments as it makes up total imports and exports. If a country has a balance of trade deficit, it imports more than it exports, and if it has a balance of trade surplus, it exports more than it imports.
Receipts from income-generating assets such as stocks (in the form of dividends) are also recorded in the current account. The last component of the current account is unilateral transfers. These are credits that are mostly worker’s remittances, which are salaries sent back into the home country of a national working abroad, as well as foreign aid that is directly received.
The Capital Account
The capital account is where all international capital transfers are recorded. This refers to the acquisition or disposal of non-financial assets (for example, a physical asset such as land) and non-produced assets, which are needed for production but have not been produced, like a mine used for the extraction of diamonds.
The capital account is broken down into the monetary flows branching from debt forgiveness, the transfer of goods, and financial assets by migrants leaving or entering a country, the transfer of ownership on fixed assets (assets such as equipment used in the production process to generate income), the transfer of funds received to the sale or acquisition of fixed assets, gift and inheritance taxes, death levies and, finally, uninsured damage to fixed assets.
The Financial Account
In the financial account, international monetary flows related to investment in business, real estate, bonds, and stocks are documented. Also included are government-owned assets such as foreign reserves, gold, special drawing rights (SDRs) held with the International Monetary Fund (IMF), private assets held abroad, and direct foreign investment. Assets owned by foreigners, private and official, are also recorded in the financial account.
Deficit and Surplus
In theory, the current account should balance with the capital plus the financial accounts. The sum of the balance of payments statements should be zero. For example, when the United States buys more goods and services than it sells (a current account deficit), it must finance the difference by borrowing, or by selling more capital assets than it buys (a capital account surplus). A country with a persistent current account deficit is, therefore, effectively exchanging capital assets for goods and services. Large trade deficits mean that the country is borrowing from abroad. In the balance of payments, this appears as an inflow of foreign capital. In reality, the accounts do not exactly offset each other, because of statistical discrepancies, accounting conventions and exchange rate movements that change the recorded value of transactions.