COMPONENTS OF BALANCE OF PAYMENTS

COMPONENTS OF BALANCE OF PAYMENTS

COMPONENTS OF BALANCE OF PAYMENTS

Introduction

The Balance of Payment (BOP) refers to a financial document that contains all the monetary transactions done between citizens of a given country with the entire world over a specified period. The report contains individual, corporate and federal transactions. The BoP is employed to monitor the flow of funds that assist in building the economy. In a perfect scenario, when all components of the BoP are accurately included, the sum total is zero. The nil totals imply that inflows and outflows balance out. Through the BoP report, a country can identify whether it has deficits or surpluses. Therefore, the BoP helps understand when to increase imports over exports and vice versa. There are two types of BoP namely Current Account (CA) and Capital and Financial Account (CFA). Transactions that create liability for an economy are covered under the CFA. Contrastingly, transactions that have no liability are categorized under CA.

Components of Balance of Payment

Capital Account(Asset)

Financial Account(Investments and Intangibles)

BoP Components

Current Account (CA)(Goods and Services)

There are three divergent components of the BoP namely the Current Account, Capital Account and Financial Account. According to Gibson and Thiriwall (2016, p. 3), economists normally assert that there are two types of BoP because the current account must balance when compared to the combined financial and capital accounts. The figure below presents an illustration of the different properties contained per BoP component.

Current Account

The CA is employed to control the inflow and outflow of goods and services between nations. The financial report includes receipts and payments associated with the transfer of raw materials and finished products. The report equally includes payments from industries, such as transport and tourism and receipts from stocks, royalties, patent and copyrights (Hale 2013, p. 2). With all the payments combined, the report has the same structure and content as the country’s Balance of Trade (BoT). Important to note is that the BoP covers various categories of transactions between countries. The transfer can be unilateral payments or visible or invisible trading. Transactions involving the sharing of finished goods are what is termed as visible trading where transactions in banking or information technology is referred to as invisible trading (Gibson & Thiriwall 2016, p. 3). Unilateral transfers entail money shared in the form of donations or gifts to citizens of foreign republics.

Capital Account

            The account monitors all capital transactions done between countries. The transfers include the selling of assets (non-fiscal properties). The account also entails information on the flow of taxes and the transfer of fixed assets, such as migrants. Deficits or surpluses under the current account are balanced out by transactions done under the capital account. There are three primary components of the capital account, namely loans & borrowing, foreign exchange reserves and investments.

1. Loans & Borrowing: Entails all forms of loans from the public and private sectors present in international markets.
2. Investments: Covers all funds invested in corporate stocks by non-residents (Gibson & Thiriwall 2016, p. 3)
3. Foreign Exchange Reserves: These are foreign currencies held by the central bank to help monitor and manage the exchange rate in order to ascertain transactions do not negatively impact the capital account.

Financial Account

            The account details the flow of funds in and out of foreign economies through investment transactions in segments such as real estate, foreign direct investments and business ventures. The account measures the transfer in foreign ownership of national assets and domestic ownership of international assets. Through the financial account, economies can determine whether they are losing or acquiring more assets.

Purpose of the BoP

            The BoP is a financial report that provides a vivid description of the state of economic relations between one country and another. Therefore, the document is an important tool for international financial management. As a start, the BoP provides information concerning the demand and supply of the national currency. The trade data will outline whether the local currency is appreciating or depreciating in comparison to the partner country engaged in the transactions. Secondly, countries employ the BoP to determine whether another country is a potential constructive trade partner. Comparisons of the BoP helps international markets come up with a list that indicates a country’s position in global economic growth.

References

Gibson, H & Thiriwall A 2016, ‘Balance of payments theory and the United Kingdom experience’, Springer, New York.

Hale, G 2013, ‘Balance of payments in the European periphery’, FRBSF Economic Letter, vol. 13, no. 1, pp. 1-7.