Balance of Payments

The balance of payments account for one country records all the payments that affect funds transfers between that nation and the rest of the world. Payments from foreigners to the domestic country are credits (+) to the account. These include all foreign payments for exports, payments from foreign tourists for services, investment income made by the domestic country in foreign markets, unilateral transfers (presents received by domestic citizens from foreigners), and capital inflows (when foreigners purchase domestic assets).

Conversely, payments by domestic citizens to foreigners are debits (-) to the balance of payments account. Imports, payments for services made by domestic citizens traveling abroad, investment earned in the domestic country by foreigners, unilateral transfers, and capital outflows are all examples.

If a South African citizen is given a Mercedes while working in Germany, that is a unilateral transfer to South Africa. When a Saudi oil tycoon buys a Japanese baseball team, Japan gains a capital inflow. Capital outflows are just the opposite. Saudi Arabia would have a capital outflow in the latter example, and Germany would have a capital outflow in the former.

A country’s exports, less its imports, is known as the trade balance. If imports are greater than exports, the country has a trade balance deficit. The United States has had such a deficit for many years. People in the U.S. are importing (buying foreign goods) more than they are exporting (selling domestic goods). If exports are greater than imports, a trade balance surplus results.

The current account balance equals the trade balance, plus net investment income, net services, and net unilateral transfers. Capital account balance equals capital outflows (credits) plus capital inflows (debits).

To determine the balance of payments for a country, the current account balance, the capital account balance, and the method of financing are added together. Method of financing is the way a country chooses to pay for the change in reserves (balance of payment deficit or surplus). Either international reserves decrease (for a deficit) or increase (for a surplus). The balance of payments will always equal zero. Why? Because the financing will balance out the surplus or deficit caused by the current and capital accounts. A brief example: Current account balance of country A equals -50 and capital account balance equals +10. (-50 + 10 = -40). Country A has a balance of payments deficit; it spent more internationally than foreigners spent in Country A. To finance the deficit, Country A will increase its foreign official assets by 40, resulting in account equilibrium. (40 + -40 = 0).