The essentials
The balance of payments (BoP) is a systematic record of all economic transactions between the residents of a country and the rest of the world during a year. It has two main parts.
Current account: records trade in goods (visible items), services (invisible items such as transport, banking, tourism and software), income (wages, interest, profits from abroad) and transfers (gifts, remittances). The balance of trade (BoT) is exports of goods minus imports of goods. The current account balance adds services, income and transfers to this.
Capital account: records transactions that change a country's foreign assets and liabilities, such as foreign direct investment (FDI), foreign portfolio investment, external commercial borrowings and loans from abroad.
Key points
- Receipts from abroad are credit items (+); payments to abroad are debit items (−).
- Autonomous transactions take place for their own sake, for profit or other economic motives. They are "above the line".
- Accommodating transactions are made to cover the gap in autonomous transactions, such as changes in the official foreign exchange reserves of the RBI. They are "below the line".
- BoP surplus: autonomous receipts > autonomous payments; reserves rise.
- BoP deficit: autonomous receipts < autonomous payments; reserves fall.
- In an accounting sense the BoP always balances, because accommodating items fill the gap.
Exam tips
Classify each transaction by asking: is it a flow of goods, services, income or transfer (current account), or a change in ownership of assets or liabilities (capital account)?
Common mistakes
- Confusing balance of trade with balance of payments.
- Putting remittances from abroad in the capital account; they are current transfers.