In economics, the balance of payments (BOP) is a statement that summarizes the economic transactions between a country and the rest of the world. Furthermore, the BOP is essentially a link between a nation’s domestic economy and the global economy. Additionally, the document reports the inflows and outflows of goods, services, and capital between a domestic economy and the world economy over a period of time.
The balance of payments consists of three main categories that include the current account, the capital account, and the financial account. Each account consists of sub-accounts. The sum of the accounts on the balance of payments must theoretically add up to zero in order to balance the statement. Furthermore, the balance of payments is an economic indicator used to assess the conditions of a nation’s economy. The data are watched closely by economists, investors, foreign currency traders, businesspeople, and other interested parties. In the United States, the balance of payments is published quarterly by the Commerce Department.
The current account includes the net inflows and outflows of goods, services, and unilateral transfers. Net inflows and outflows of tangible goods, or visible trade, refers to the net imports and exports of physical merchandize between the domestic economy and the rest of the world. Net inflows and outflows of services, or invisible trade, refers to the payments and receipts of services and intangible goods, such as banking, insurance, tourism, shipping, and air travel. Unilateral transfers includes inflows and outflows of capital related to gifts, grants, charitable donations, pensions, and money earned domestically by foreign workers that is sent back to their home country.
The capital account includes net inflows and outflows relating to payments for and capital transfers of fixed assets and fixed asset financing. You can divide capital account items into short-term capital flows and long-term capital flows. Short-term capital flows may include inflows and outflows relating to foreign currency speculation. Whereas, long-term capital flows may include money invested in foreign assets or proceeds gained from the sale of foreign assets.
The financial account includes net inflows and outflows of investments and financial assets. Divide this category into net foreign direct investments, net portfolio investments, and net other investments. Direct investments refer to net capital investments of over 10% in equity stakes; they represent the ownership or management control of a foreign entity. Portfolio investments refer to net capital investments in stocks, bonds, and other financial assets that do not involve ownership or management control of a foreign entity. Other investments refers to net inflows and outflows of financial assets and instruments such as bank deposits.
The official reserve account represents changes in asset values of the nation’s central bank. This account includes items such as foreign exchange reserves, official gold reserves, and special drawing rights (SDRs). Special drawing rights are assets the value of which are based on a basket of underlying currencies. The International Monetary Fund (IMF) issues SDRs.
The balance of payments typically includes a line item labeled statistical discrepancy, or errors and omissions. Furthermore, this represents the amount by which the balance of payments did not actually balance. A nation’s balance of payments should balance out to zero, when incorporating all relevant inflows and outflows of capital. When there is a discrepancy and the accounts to not balance out, record the difference in the account for errors and omissions.