The Balance of Payments (BOP ) is a measure of all the financial transactions flowing between one country and all other countries during a specific period, usually a quarter or a year. It is also the name of the official record of these transactions. A positive, or favorable, balance of payments is one in which more payments have come in to a country than have gone out. A negative or unfavorable balance means more payments are going out than coming in.

The BOP is a major indicator of a country’s status in international trade, and a reflection of its economic well-being or vulnerability. The balance of trade is one component of the balance of payments. It is also a sign of the productiveness of a people and a reflection of whether they are primarily producers or consumers.

Contents

Components

Within any country, the BOP record comprises three accounts: the current account. which includes primarily trade in goods and services (often referred to as the balance of trade), along with earnings on investments; the capital account. including transfers of non-financial capital such as debt forgiveness, gifts and inheritances; and the financial account. essentially trade in such assets as currencies, stocks, bonds, real estate, and gold, among others. [1] [2]

Each of these components is further divided into subcomponents. Thus, for example, the current account comprises trade in merchandise, trade in services (such as tourism and law), income receipts such as dividends, and unilateral transfers of money, including direct foreign aid. (To economists, the current account is viewed as the difference between exports and capital inflows, on one hand; and on the other hand, imports and capital outflows. )

Likewise, the capital account includes such transfers as debt forgiveness, money that migrant workers take home with them when they leave the country or bring with them as they enter the country, and sales and purchases of natural resources. The financial account consists both of assets owned abroad, and of foreign-owned assets within the country. [3]

In the financial account, if foreign ownership of domestic financial assets has increased more quickly than domestic ownership of foreign assets in a given year, then the domestic country has a financial account surplus. On the other hand, if domestic ownership of foreign financial assets has increased more quickly than foreign ownership of domestic assets, then the domestic country has a financial account deficit. The United States persistently has the largest capital (and financial) surplus in the world, [4] but as of 2006 had a large account deficit. [5] To a significant extent, this reflects that the United States imports far more than it exports.

Taken together, the capital and financial accounts consist of capital transfers, direct investments [in which the investor has a permanent interest], portfolio investments [stocks, bonds, notes and the like] and other forms of investment [financial derivatives, loans, etc.]. [6]

Recording Procedures

The method of recording these payments explains the balance. As payments leave or enter a country—perhaps to finance a purchase, or to invest in a foreign corporation—the transactions are recorded as both debits and as credits, in accordance with the practice of double-entry bookkeeping that is the standard business accounting practice. [7] For example, when a country or any of its citizens buys a foreign good—such as furniture—that is treated as an increase in the asset of furniture. Therefore, that recording is made, according to convention, by a debit-entry in the books of the current account (i.e. on the left side of the ledger). At the same time, that same entry is countered, or balanced, by a decrease in the asset of money, which is recorded by a credit-entry (on the right side of the ledger) of the capital account.

Credits and debits

In brief, according to the International Monetary Fund. a country records credit entries for (a) exports of goods and services, provision of services, provision of the factors of production to another economy, and (b) financial items reflecting a reduction in the [country’s] external assets or an increase in external liabilities. Likewise, it records debit entries for (a) imports of goods, acquisition of services, use of production factors provided by another economy, and (b) financial items reflecting an increase in assets or a decrease in liabilities. [8]

Therefore, the current account should always balance, or equal, the sum of the capital and financial accounts. For example, when a country buys more goods and services than it sells [resulting in] a current account deficit, it must finance the difference by borrowing, or by selling more capital assets than it buys [resulting in] a capital account surplus. A country with a persistent current account deficit is, therefore, effectively exchanging capital assets for goods and services. [9]

In practice, however, perfect balancing is not always the case, given statistical discrepancies, accounting conventions, and exchange rate movements that change the recorded value of transactions. [10]

Prices and currency issues

The value of each balance of payments transaction is measured largely by market prices, or the prices actually paid between a buyer and a seller, rather than the price that is officially quoted. [11] Those prices, in turn, are usually recorded in terms of a country’s domestic currency. However, for international comparisons, economists use a more stable or solid currency, such as the U.S. dollar.

Currency strength, therefore, is one of several factors influencing a nation’s balance of payments, and indeed its overall economy. (Other factors include degree of industrialization, education and skill levels of labor force, stability of government, etc.) For example, if a domestic currency is over valued [relative to other currencies], the balance of payments would be in deficit, money would be reduced, and deflation would be imposed, bringing in its wake unemployment. On the other hand, if a currency is undervalued, balance of payments surplus would produce inflationary pressure that could change expectations and set in motion a wage explosion that might overshoot the equilibrium. [12]

Policy Uses

Data from the balance of payments, along with information from a country’s International Investment Position (a record of the nation’s stock of outstanding foreign assets and liabilities) are useful as indicators for economic policy makers. For example, a current account deficit, which usually reflects an imbalance between imports and exports, may suggest a policy directed to increase competitiveness in the global market for local products and/or develop new industries that will produce import substitutes, or a policy focused on currency exchange rates,such as devaluation. [13]

Likewise, a steep current account deficit can lead policy makers to impose tariffs, which effectively slow imports, or lower interest rates, which enable domestic manufacturers to lower their own prices, thereby better competing with demand for imports. Other measures suggested by payments imbalances might include restrictive monetary and fiscal policies, or increasing borrowing. [14]

IMF Balance of Payments Manual

The Balance of Payments Manual is a manual published by the IMF that provides accounting standards for balance of payments reporting and analysis for many countries. The Bureau of Economic Analysis adheres to this standard.

The sixth edition was released in prepublication form in December 2008. Its title has been amended to Balance of Payments and International Investment Position Manual to reflect that it covers not only transactions, but also the stocks of the related financial assets and liabilities.

The following list of countries and territories by current account balance (CAB) is based on the International Monetary Fund data for 2007, obtained from the World Economic Outlook database (October 2008). [15] Numbers for 2008 should become available in April 2009. Estimates are highlighted.