BALANCE OF PAYMENTS: CHARACTERISTICS, STRUCTURE, EXAMPLES - ECONOMY - 2025

The balance of payments reflects all payments and obligations abroad against all payments and obligations received from abroad between the different entities of a country during a defined period of time. It is a record of all financial flows in and out of a country.

The balance of payments indicates whether a country is saving enough to pay for its imports. It also reveals whether the nation generates sufficient economic production to pay for its development.

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A deficit in the balance of payments means that the country imports more products, capital and services than it exports. Therefore, it must borrow from other countries to pay for its imports. In the short term, that supports the country's economic growth. It's like taking out a school loan to pay for education.

In the long term, the country becomes clearly a consumer, not a producer, of world economic production. You will have to go into debt to pay for consumption, rather than investing in future growth.

If the deficit continues long enough, the country may have to sell its assets to pay off its creditors. These assets include natural resources, land, and commodities.

Balance surplus

A balance of payments surplus means that the country exports more than it imports. Your government and residents are savers. They provide enough capital to pay for all national production. They could even lend money outside the country.

A surplus boosts economic growth in the short term. You have enough additional savings to lend to the countries that buy your products. Increased exports increase production in factories, allowing more people to be hired.

In the long term, the country becomes too dependent on growth driven only by exports. You should encourage your residents to spend more. A larger domestic market will protect the country from fluctuations in exchange rates.

characteristics

The balance of payments contains all the transactions that individuals, government agencies and companies in a country carry out with other entities outside the nation.

These transactions consist of exports and imports of products, capital and services, as well as remittances and foreign aid. A country's net international investment position and its balance of payments constitute its international accounts.

The sum of all transactions recorded in the balance of payments should be zero, when the capital account is broadly defined. This is because each credit in the checking account has its corresponding debit in the capital account, and vice versa.

However, in practice statistical differences are generated due to the difficulty of accurately counting each one of the transactions carried out between any economy with the rest of the world.

If a country exports a product, being a credit from the current account, it is importing foreign capital when that item is paid for, being a debit from the capital account.

If a country, through its capital exports, cannot finance its imports, it must do so by reducing its central bank reserves.

Economic politics

Certain aspects of balance of payments information, such as foreign direct investment and payment imbalances, are key issues addressed by a nation's policy makers.

For example, a country could adopt outlined policies to attract foreign investment in some sector. Another country might seek to artificially keep its currency low in order to encourage exports and increase its reserve of foreign exchange.

Structure of the balance of payments

-Current account

It measures a country's international trade, plus the effects of net income on investments and direct payments. It is made up of trade in goods, services, and one-way transfers.

When the activities of the people of a country provide sufficient income and savings to finance all their purchases, business activities, and government infrastructure expenditures, then the current account is balanced.

Deficit

A current account deficit is when the residents of a country spend more on imports than they save. To finance the deficit, other countries lend money or invest in the companies of the deficit country.

The lending country is generally willing to pay the deficit. However, if the deficit is maintained for a long time, it will slow economic growth, because foreign lenders will begin to wonder if they will get an adequate return on their investment.

Balance of trade

It measures the imports and exports of a country. This is the largest component of the current account, which is the largest component of the balance of payments.

Trade deficit

It occurs when a country imports more than it exports. Imports are goods and services produced in a foreign country, even if they are produced abroad by a domestic company.

-Financial account

Describes changes in international ownership of assets. The financial account documents international monetary flows related to investment in businesses, real estate, bonds, and stocks.

Government assets such as foreign reserves, gold, private assets abroad, and foreign direct investment are also included. If foreign ownership increases more than domestic ownership, a deficit is created in the financial account.

-Capital account

It measures financial transactions that do not affect a country's production, savings or income. Contains transfers of financial assets, such as tax payments and transfers of securities to assets.

International balance of payments

Most of the countries of the world have their own national currency, used as money within the respective countries.

Although all currencies are money, most of the world's money is actually stored as electronic information, such as checking and savings accounts in bank databases.

If a domestic resident wishes to purchase a foreign product or service, they must first convert the domestic currency to the foreign currency to make the purchase.

If a company wants to sell products in a foreign country, then the company will charge foreign exchange for those sales. When the business receives the payment of that money, it will convert the foreign currency to its national currency.

The international balance of payments is a photograph of the net result of these international transactions during a specific period of time: monthly, quarterly or annually.

Debit and credit

Each international transaction is a credit or debit of the balance of payments. Credits are transactions that increase national income or liabilities, or that decrease assets or expenses.

On the other hand, balance of payments debits are transactions that are opposite to credits.

Therefore, if a resident of the United States purchases an Australian bond, the payment of the bond will be by credit, and the debit of the balance of payments will be the result of increasing foreign values ​​by the United States.

If an American company imports goods, the increase in assets translates into a balance of payments debit, while the responsibility to pay for the goods is a credit.

Capital account

It refers to the acquisition or disposal of non-financial assets, such as a physical asset, such as land, and assets that are necessary for production, but have not been produced, such as a mine used for the extraction of diamonds.

The capital account is made up of the monetary flows derived from debt forgiveness, transfer of goods and financial assets of migrants who leave or enter a country, transfer of ownership of fixed assets.

Also by transfer of funds received from the sale or acquisition of fixed assets, taxes on donations and inheritances, etc. The capital and financial account records the flows of capital and finance between a country and the rest of the world. Types of flow include:

Real foreign direct investment

It refers to investment in a company where the owners or shareholders have some element of control of the business. For example, a company in the United States that establishes a manufacturing plant in China.

Portfolio investment

For example, an investor from a country who buys shares in an existing business abroad. With portfolio investing, the investor does not have control over the company.

Financial derivatives

They are any financial instrument whose underlying value is based on another asset, such as foreign currency, interest rates, raw materials or indicators.

Reserve assets

They are foreign financial assets controlled by the country's monetary authorities, that is, the central bank. These assets are used to finance deficits and deal with imbalances.

Reserve assets include gold, special drawing rights, and currencies held by the country's central bank.

Balance of transfers

They are unilateral transfers of money, goods or services from one country to another, where nothing is received in return.

They include workers' remittances, donations, aid and subsidies, official assistance and pensions. Due to their nature, transfers are not considered real resources that affect economic production.

In a unilateral transfer, one party is making a transfer to the other party. They are not receiving anything from the other party.

Unilateral transfers often involve donations to governments, foreign aid, or any transaction in which one party agrees to deliver and then grant payments or items to another country, population, or government without receiving anything in return.

This can be contrasted with a bilateral transfer. A bilateral transfer involves two parties exchanging goods, money, or services.

Unilateral transfers are included in the current account of a nation's balance of payments. They are different from international trade, which would be a bilateral transfer, since two parties are involved in the trade.

Unilateral transfers include such things as humanitarian aid and payments made by immigrants to their former country of residence.

Errors and omissions in the balance of payments

In theory, the balance of the sum of the capital and financial accounts must be balanced with the balance of the current account, so that the general account is balanced, but in practice this is only achieved through the use of an accounting balance called net errors and omissions.

This device compensates for the different errors and omissions in the balance of payments data, which will make the account of this final balance be zero.

With fluctuating exchange rates, the change in the value of money can increase discrepancies in the balance of payments.

Surplus and deficit

A surplus is indicative of a creditor economy for the rest of the world. It shows how much a country is saving instead of investing. The surplus will be available to buy gold or currency, or to pay debts.

A country with a surplus allows other economies to increase their productivity, and also to run a deficit.

A deficit reflects an economy in debt to the rest of the world. It invests more than it saves and uses resources from other economies to meet its domestic consumption and investment needs.

When there is a deficit in the current account, the difference can be borrowed or financed from the capital account.

Financing the deficit is achieved through the sale of gold or foreign exchange. Also through loans from other central banks or the International Monetary Fund.

When a country finances its current account deficit with the capital account, the country is giving up its capital assets to have more goods and services.

Examples

Current account deficit

The US current account deficit reached a record $ 803 billion in 2006. This raised concerns about the sustainability of such an imbalance. It fell during the recession, but is now growing again.

The Congressional Budget Office warned of the danger of a current account deficit. He also proposed several solutions.

First, Americans should cut spending on credit cards and increase their savings rate enough to finance the growth of domestic businesses.

Second, the government must reduce its spending on health. The best way to do this is to reduce the cost of health care.

If these solutions don't work, it could lead to inflation, higher interest rates, and a lower standard of living.

Balance of trade

In 2017, the United States exchanged $ 5.2 trillion with foreign countries. That was $ 2.3 trillion in exports and $ 2.9 trillion in imports. It is the third largest exporter, but the main importer.

One of the main impediments to being able to increase their exports is that other countries have lower costs of living. They can make things cheaper, because they pay their workers less.

It could all be done in the US, but it would cost a lot more. US imports cost less than domestically made products.

Trade deficit

A large part of the US trade deficit is due to the dependence of this country on foreign oil. When oil prices go up, so does the trade deficit.

Many automobiles and consumer products are also imported. US exports include many of the same things, but not enough to overcome the deficit.

References

1. Investing Answers (2018). Balance of Payments (BOP). Taken from: investinganswers.com.
2. Will Kenton (2017). Balance of Payments (BOP). Taken from: investopedia.com.
3. This Matter (2018). International Balance of Payments (BOP). Taken from: thismatter.com.
4. Kimberly Amadeo (2018). Balance of Payments, Its Components, and Deficit Versus Surplus. The Balance. Taken from: thebalance.com.
5. Will Kenton (2017). Unilateral Transfer. Investopedia. Taken from: investopedia.com.
6. Economics Online (2018). The balance of payments. Taken from: economicsonline.co.uk.