The Balance of Payments records a country's international transactions divided into the current account and capital account. The current account comprises trade in goods and services, income from foreign assets and payments on domestic assets owned by foreigners. If exports exceed imports it results in a trade surplus, but if imports exceed exports it results in a trade deficit. The capital account records transactions in real and financial assets between countries like FDI, portfolio investment and changes in official foreign exchange reserves. For the payments to balance, a current account deficit must be matched by an equal capital account surplus.

1. Balance of Payments

2. Balance of Payments
• Balance of Payments records a country’s
international transactions
• Transactions can be between
governments, companies, individuals
• Divided into
– Current account
– Capital account

3. Current Account
• An important long run and comprehensive measure of
country’s transaction with the rest of the world
• Comprises of trade in goods and services and income
from assets abroad and payment on foreign owned
assets in the country
• Trade in goods results in Merchandise trade balance:
net balance of exports minus imports on merchandise
(goods)
• Trade surplus = exports>imports (Inflow of cash>outflow
of cash)
• Trade deficit = exports<imports (Inflow of cash<outflow
of cash)

4. Current Account
• Trade in services includes freight, passenger
fares, royalties, fees, tourism
• Other important component is net investment
income, interest, profits
• Unilateral transfers include relief funds, grants,
income earned by guest workers
• Simple rule of BoP accounting is that any
transaction that gives rise to payment by a
country is a deficit item in that country’s BoP.

5. Capital Account
• Capital Account shows transactions in real or
financial assets between countries
–
–
–
–
Purchase of real estate
FDI, FII
Purchase and sale of securities
Changes in official reserves of gold, silver, SDRs, and
foreign exchange
• Transaction of private sector
• Official reserves transaction (by central bank)

6. External account must balance
• Payments to abroad=receipts from abroad
• Current account deficit has to be compensated with
capital account surplus
• Current account deficit is financed by
– Private sector by selling off assets or borrowing abroad
– Govt. runs down its official reserves
• In case surplus,
– private sector can buy assets abroad or pay off past debt or
– Central bank can buy foreign exchange earned by private sector
and increase reserves

7. External account must balance
• Increase in official reserves is called balance
of payments surplus
• Balance of payments surplus = Increase in
official reserves = current account surplus+ net
private capital inflow
• Balance of payments deficit is a bad news
– Means both current and capital accounts are in deficit
– Central bank is losing reserves
• current account deficit is just equal to capital
account surplus, BoP is neither surplus nor
deficit

8. Importance
• Balance of payments data influence the
exchange rates and government policy
• Corporate monitor Balance of Payments
to watch for factors that could lead to
currency instability or government actions
to correct an imbalance
– Large current account deficit is a bad signal:
unstable currency exchange rates

9. Balance of payment
Debits (+)
Credits (-)
Current Account
Export of goods Services
Income receipts
Import of goods and Services
Income payments
Unilateral transfers (Net)
Capital Account
Capital Account transactions (net)
Financial Account (net official reserves)
Amount

10. Balance of payment
Debits (+)
Credits (-)
Current Account
Export of goods Services
Income receipts
Import of goods and Services
Income payments
Unilateral transfers (Net)
Capital Account
Capital Account transactions (net)
Financial Account (net official reserves)
Amount