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What components make up balance of payments?

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What is the Balance of Payments (BOP)?

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The Balance of Payments (BOP) is a way for countries to keep track of all the money moving in and out of their borders. It’s like a big financial diary that records every international transaction, whether it’s buying and selling goods, investing in other countries, or even tourists spending money.

The BOP has 3 main parts (these will be discussed further later on):

Current Account: This tracks the trade of goods and services
Capital Account: This records transfers of money and assets
Financial Account: This keeps tabs on investments going in and out of the country

Countries use the BOP to see if they’re spending more money internationally than they’re bringing in (a deficit), or if they’re earning more than they’re spending (a surplus). It helps governments and economist understand a country’s economic health and its relationships with other nations.

Ideally, all the money coming in and going out should balance perfectly, but in real life there’s usually a bit of a difference. That’s why it’s called a “balance” of payments - we’re always trying to keep things as balanced as possible!

Current Accounts

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The Current Account is a crucial part of a country’s Balance of Payments. Think of it as a country’s financial report card for its dealings with the rest of the world. The Current Account focuses on 3 main components:

Trade Account

Goods - Physical items a country buys from or sells to other countries, like cars, clothes or food
Services - Things you can’t touch but still pay for, such as tourism, transportation, or business services

Primary Income Account

Investment income - Earnings from foreign investments (e.g., profits, dividends, interest payments)
Compensation of employees - Wages and salaries paid to workers who are employed in a country different from where they live (e.g., cross-border workers or seasonal foreign labourers)
Other primary income - Earnings from rent, taxes, and subsidies on production and imports

Secondary Income Account

Transfer - Provision of economic value without a direct counterpart, including:

Remittances (money sent home by people working abroad)
Foreign aid given or received
Government transfers (e.g., contributions to international organisations)

The difference between the total credits and debits across these accounts determines the current account balance. A country can have either a Current Account surplus or deficit.

Surplus: Overall credits exceed debits
Deficit: Overall debits exceed credits

For example, in the second quarter of 2023, the United States had a Current Account deficit of $212.1 billion, indicating it was importing more than it was exporting (US Bureau of Economic Analysis).

Capital Accounts

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While the Current Account deals with day-to-day transactions, the Capital Account focuses on larger, often one-time events that involve significant changes in a country’s assets or liabilities.

It includes transactions like buying or selling land in other nations, transferring ownership of valuable resources like mines, and tracking the wealth that moves when people immigrate or emigrate. Furthermore, it covers things like debt forgiveness between countries and large cross-border gifts or inheritances.

This is important because it helps economists and policymakers understand:

How attractive the country is to foreign investors
The country’s overall financial health and stability
Potential impacts on exchange rates

The Capital Account works in tandem with the Current Account. Often, they balance each other out. For example, if a country has a trade deficit in its Current Account (meaning it’s importing more goods and services than it’s exporting), it might have a surplus in its Capital Account. This could mean that while the country is buying more goods from abroad, it’s also attracting a lot of foreign investment.

Financial Accounts

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The Financial Account is a vital component of a country’s Balance of Payments, tracking international investment activities and money movements across borders. It essentially records what your country owns abroad and what foreigners own in your country.

The financial account covers several types of international financial transactions:

Direct Investment - Ownership of foreign businesses
Portfolio Investment - Stocks and bonds in foreign markets
Other Investments - Bank deposits and loans across countries
Reserve Assets - Foreign currencies and gold held by central banks

When money or assets enter your country from abroad, it’s an inflow, recorded as a positive value. When they leave your country, it’s an outflow, recorded as a negative value.

By analysing the Financial Account, we can gauge foreign investor confidence in our economy and how our own investors view opportunities abroad.