country's balance-of-payments (bop)
is an accounting statement that summarizes all the economic transactions of that country's citizens, businesses, and governments with citizens, businesses, and governments of all other countries.
Examples of balance-of-payments
Export and import of goods and services; cross-border investments in businesses, real estate, and financial assets; financial aid provided to or received from other countries, etc.
The financial inflows to a country (receipts from foreigners)
are treated as credits (with a positive sign)
The financial outflows from a country (payments to foreigners)
are treated as debits (with a negative sign)
An export from the U.S. creates
financial inflow to the U.S.
An import to the U.S. creates
financial outflow from the U.S.
A Japanese firm setting up a plant in the U.S. creates
financial inflow to the U.S.
An American firm setting up a plant in Europe creates
financial outflow from the U.S.
Asian investors purchasing T-bills in the U.S. create
financial inflow to the U.S.
The Balance-of-Payments Statement is based on double-entry bookkeeping
For every credit in the account, there is a matching debit, and vice-versa.
While double entry bookkeeping is to be employed in a BoP statement as per theory,
it isn't always practical.
A country's international transactions can be grouped into three main types:
Current account. Capital account. Official reserve account
statistical discrepancies
reflects omitted and misrecorded transactions, and the fact that double entry bookkeeping is employed in theory but not in practice.
The current account reflects
the net flow of goods, services, income, and unilateral transfers.
current Account: Merchandise trade
Exports and imports of tangible goods
current Account: Services
Payments and receipts for legal, engineering, consulting, and other services and tourist expenditures.
current Account: Income
Payments and receipts of interest, dividends, and other income on foreign investment.
current Account: Unilateral transfers
Gifts, foreign aid, pension payments and receipts, and other cross-border transfers for which no specific services are rendered.
Capital Account
The capital account reflects investment and lending activities.
Capital Account: Direct investment
A cross-border investment in which the investor acquires a measure of control of the foreign business. In the US Balance-of-Payments, acquisition of 10% or more of voting shares is considered a direct investment.
Capital Account: Portfolio Investment
Sales and purchases of foreign financial assets such as stocks and bonds, that do not represent a controlling interest and have a maturity greater than one year.
Capital Account: Other investment
Other investments, such as sales and purchases of foreign financial assets with maturity less than one year.
Official Reserve Account
is the total reserves held by official monetary authorities within the country.
These reserves include the major foreign currencies used in international trade such as
the USD, EUR, JPY, GBP, etc.
Let "B" be a country's balance-of-payments after cumulating the current account, the capital account, and any statistical discrepancies.
This is known as the overall balanceorofficial settlement balance.
The change in Official Reserve Account offsets
the above surplus or deficit (B).
If there is a deficit, i.e. B < 0
then the balance on official reserves would be positive. There would be a decrease in the country's official reserves (gold and foreign currencies). [A decrease in gold and foreign currencies implies a "source" of dollars.] For example, if the US has a de
The opposite would be true if there is a surplus, i.e. B > 0
and there would be an increase in the country's official reserves.
Sale of super computers to France
Current account, merchandise trade, credit
Purchase of wine from France
Current account, merchandise trade, debit
Licensing fees earned by Microsoft from software buyers in Switzerland
Current account, services, credit
Spending by American tourists in Africa
Current account, services, debit
Interest earned by American banks on loans made to other countries
Current account, income, credit
Payment of $25 million in social security benefits to Americans living in Europe
Current account, unilateral transfer, debit
Japanese automakers setting up auto plants in the U.S.
Capital account, direct investment, credit
Americans purchasing stocks of Chinese firms
Capital account, portfolio investment, debit
Japanese investors purchasing U.S. Treasury-bills:
Capital account, other investment, credit
Sale of gold by the U.S. treasury:
Official Reserve Account, credit (since sale of gold is a "source" of dollars)
Increase in holdings of Euros by the Federal Reserve
Official Reserve Account, debit (since increase in FX holdings is a "use" of dollars)
Trade Balance =
Exports of goods -Imports of goods
Services Balance =
Exports of services -Imports of services
Income Balance =
Income receipts -Income Payments
Current Account Balance=
-Capital Account Balance
One way to sustain a current account deficit is by using the official reserves. However,
that will lead to a depletion of reserves.
a current account deficit can be sustained on a long-term basis only with
a capital account surplus