Understanding the Balance of Payments: Components and Analysis

Understanding the Balance of Payments

The Balance of Payments (BOP) is a systematic record of all economic transactions, both real and financial, between the residents of one country and the rest of the world during a specific period. The accounting is determined by specific criteria.

Accounting Criteria

The actual operations of the balance of payments are recorded in terms of income from payments and financial transactions, reflecting changes in liabilities and asset variations (VA). Balances are derived from these columns by calculating the differences between expenditure and revenue, and between changes in liabilities and asset variations. The annotation criterion used is a systematic record that departs from the double-entry method.

Effects of the Accounting Method

This method produces two key effects:

• The balance of payments always equals zero.
• The sum of all balances is equal to zero.

Items can be grouped based on the behavior you want to study, with the remaining items considered as compensating for discrepancies. To account for potential discrepancies, the balance includes errors and omissions.

Current Account

The current account is the primary aggregation within the balance of payments, composed of the following balances:

Balance of Goods

This includes transactions involving goods or merchandise between resident and non-resident entities. Exports are noted in the income column, and imports are recorded in the payments column.

Service Balance

This reflects exports of services and is logged as income.

Income Balance

This includes income from employment and capital employed by residents in the rest of the world, as well as payments to foreign labor and capital used domestically.

Current Transfers

These are receipts and payments made without consideration, involving both public and private entities.

The sum of these four sections yields the total receipts and payments on the current account, resulting in the current account balance (CAB). If the CAB is positive, spending is less than disposable income, and savings exceed domestic investment, indicating a current account surplus. Conversely, if the CAB is negative, spending exceeds income, and savings are insufficient to finance investment projects, resulting in a current account deficit.

Capital Account

This account includes the annotation of capital transfers (TK). Capital transfers received are noted as revenue, and capital transfers made are recorded as payments. The resulting balance is the net capital transfers (TNK).

The sum of the current account and capital account balances is called the full balance. A positive balance indicates a surplus, while a negative balance indicates a need for financing and expresses the liability or debtor position of the country relative to the rest of the world:

Current Account + Capital Account = - (Financial Account + Errors and Omissions)

Financial Account

The financial account includes transactions between residents and non-residents involving financial instruments or titles. Entries in this account are made in a column reflecting changes in liabilities (VP), representing the difference between increases and decreases in liabilities, and a column reflecting changes in assets. Credits and investments also include reserves, which are a specific type of asset used to address trade needs arising from external factors.

The balance of this account (SCF) is obtained by calculating the difference between changes in assets and changes in liabilities. A positive SCF implies borrowing from abroad, while a negative balance represents external lending.