- 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.
The balance of payments is an accounting of a country's international transactions over a certain time period, typically a calendar quarter or year. It shows the sum of the transactions—purely financial ones, as well as those involving goods or services—between individuals, businesses and government agencies in that country and those in the rest of the world.
Every international transaction results in a credit and a debit. Transactions that cause money to flow into a country are credits, and transactions that cause money to leave a country are debits. For instance, if someone in England buys a South Korean stereo, the purchase is a debit to the British account and a credit to the South Korean account. If a Brazilian company sends an interest payment on a loan to a bank in the United States, the transaction represents a debit to the Brazilian BOP account and a credit to the U.S. BOP account.
The BOP statement divides international transactions into three accounts: the current account, the capital account and the financial account. The current account deals with international trade in goods and services and with earnings on investments. The capital account consists of capital transfers and the acquisition and disposal of non-produced, non-financial assets. The financial account records transfers of financial capital and non-financial capital. The accounts are further divided into sub-accounts.
The current account is composed of four sub-accounts:
- Merchandise trade consists of all raw materials and manufactured goods bought, sold or given away. Until mid-1993, this was the figure that was used when the "balance of trade" was reported in the media. Since then, the merchandise trade account has been combined with a second sub-account, services, to determine the total for the balance of trade.
- Services include tourism, transportation, engineering and business services, such as law, management consulting and accounting. Fees from patents and copyrights on new technology, software, books and movies also are recorded in the service category.
- Income receipts include income derived from ownership of assets, such as dividends on holdings of stock and interest on securities.
- Unilateral transfers represent one-way transfers of assets, such as worker remittances from abroad and direct foreign aid. In the case of aid or gifts, a debit is assigned to the capital account of the donor nation.
The capital account has two sub-accounts:
- Capital transfers include debt forgiveness and migrants’ transfers (goods and financial assets accompanying migrants as they leave or enter the country). In addition, capital transfers include the transfer of title to fixed assets and the transfer of funds linked to the sale or acquisition of fixed assets, gift and inheritance taxes, death duties, uninsured damage to fixed assets and legacies.
- Acquisition and disposal of non-produced, non-financial assets represent the sales and purchases of non-produced assets, such as the rights to natural resources, and the sales and purchases of intangible assets, such as patents, copyrights, trademarks, franchises and leases.
The financial account is made up of two sub-accounts:
- U.S.-owned assets abroad are divided into official reserve assets, government assets and private assets. These assets include gold, foreign currencies, foreign securities, reserve position in the International Monetary Fund, U.S. credits and other long-term assets, direct foreign investment and U.S. claims reported by U.S. banks.
- Foreign-owned assets in the United States are divided into foreign official assets and other foreign assets in the United States. These assets include U.S. government, agency, and corporate securities; direct investment; U.S. currency; and U.S. liabilities reported by U.S. banks.
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.