Balance of Payments: Categories and Definitions
The
Balance of Payments (BoP) records all transactions
that cross a country’s borders. The simplest way to think about it is as
a record of all payments going out to foreigners (with the reasons for those
payments), and all payments coming into the country from foreigners (with the
reasons for those payments). We give the payments coming in a plus sign, and
the payments going out a minus sign.
There
are various ways that these payments can be categorized and organized. Different organizations do it
differently. Just to keep us on our
toes, the IMF changes its categories and classifications every year or
two. This discussion is revised to reflect the categories on your
spreadsheets.
Most
BoP presentations give you two large categories: a
Current Account, which includes trade, and a Capital Account, which includes
sales and purchases of assets. Several other kinds of payments that are usually stuck in the
Current Account. If you want an
example of a typical textbook presentation, see this Wikipedia article.
The
IMF uses this basic division, but they call the Capital Account the
“Financial Account,” so that their basic division is between the
Current Account and Financial Account.
Fair enough. What’s not
fair is that they have named one of the more insignificant and obscure sub-categories
of the Financial Account the “Capital Account.” So what the IMF
calls the capital account is not what most textbooks call the capital account.
So below I’m going to follow the presentation on your
spreadsheets, but add explanation. There
are a couple of documents out there on the web that provide relatively clear
explanations of BoP items, so when they have nice
wording I quote them.
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Current
Account “The
current account measures all transactions (other than those in financial
assets and liabilities) that involve economic values and occur between
resident and non-resident entities. It also includes offsets to current
economic values provided or acquired without something of economic value in
exchange.” (Central
Bank of New Zealand) |
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Goods
are tangible, real stuff like wheat and steel and cars. The term “merchandise” is also
used for “goods.” |
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Goods: Exports f.o.b. Goods
sold to foreigners. (+) They require that foreigners make
payments to us so they take a plus
sign. Macro
Note: since exports are a source of total aggregate demand for
nationally-produced goods, changes in exports will produce corresponding
changes in national income. If other countries’ incomes rise, they will
likely import more of our goods, raising out exports. (FOB means "free on board, meaning what it
costs to get the goods to the boat (or equivalent). The alternative is CIE which means
"cost, insurance, freight, and includes additional costs to get the good
to the foreign customer.) |
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Goods: Imports f.o.b. Goods
purchased from foreigners. (-) They require that we make payments to
foreigners so they take a minus sign.
Macro Note: Generally imports will rise
or fall as total national income rises or falls, since they will represent some
part of national demand for goods. In that case both demand for imports and
demand for locally-made goods will rise. If for some reason people substitute
away from domestically-made goods toward imports, that
will tend to lower national income. Additionally, some countries may have
export industries that require significant amounts of imports. |
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Services
are purchases and sales of intangible items like tourism or
transportation. You don’t have
to ship them and you can’t store them. “In
a broad sense services are
products other than physical goods. There are two differences between
goods and services: • there is no physical
object over which ownership rights can be established • a
service cannot be traded separately from its production. The
production of a service is
linked to an arrangement made between a producer in one economy and a
consumer in another economy prior to the time that production occurs.”
(Central
Bank of New Zealand) Usually, when people talk about
“exports” they mean goods exports plus service exports, and then
they say “imports” they mean goods plus service imports. Trade balances are usually computed for
both goods and services trade. But
sometimes you will see people writing about the “merchandise trade
balance,” and then they’re not including services. |
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Services: Credit (service exports) Services sold to foreigners. (+) They require that foreigners make payments to us so they take a plus sign. (“Credit” is accounting terminology meaning “someone’s gotta pay us for this.”) |
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Services: Debit (service imports) Services bought from foreigners. (-) They require that we make payments to
foreigners so they take a minus sign.
(“Debit” is accounting
terminology meaning “we’ve gotta pay
someone for this.”) |
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“Income
covers two types of transactions between residents and non-residents: (i) those involving compensation
of employees, which is paid to non-resident
workers or received from non-resident
employers and (ii) those involving investment
income receipts and payments on external
financial assets and liabilities. ... Investment
income ... is income derived from ownership of
external financial assets and payable by residents of one economy to
residents of another economy. It includes interest, dividends, remittances of
branch profits, and direct investors’ shares of the retained earnings
of direct investment enterprises.” (European
Central Bank) In some presentations, “income” is
called “factor services”
or “factor income.”
That’s “factor” in the sense of “factor of
production,” i.e. land, labor, or capital, so you can think of it as a
payment in exchange for the use of physical capital or the use of the
principal on a loan. You may think it’s weird that
interest payments on a loan go into the current account while principal
payments go into the financial account.
But that’s how accountants see the world. |
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Income: Credit (inflows) Payments to us from foreigners that are interest on loans that we made to them, profits from physical capital (like factories) owned by our citizens in foreign countries, and income received by our workers from foreign employers. (+) This requires that foreigners make
payments to us and so takes a plus
sign. |
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Income: Debit (outflows) Payments by us to foreigners that are interest on loans to us or profits from physical capital that they own in our country, and income paid to foreign workers. (-) This requires that we make payments to
foreigners so takes a minus sign.
Macro Note: Countries that
borrow a lot will show very large amounts of interest payments out, sometimes
to the extent that half of their exports are going to pay interest on loans.
(One reason why interest payments balloon like this is that when a country
has trouble making payments on debt, it may enter into a
"rescheduling" agreement that postpones payments of loan principal
(see below) while continuing interest payments. That lets lenders keep the
loans on their books as "performing." The macro effect of this debt
burden, however, is that the country consumes a lot less than it makes, and
this can tend to reduce gross fixed capital formation, crippling prospects
for future growth. Not to mention lowering overall consumption, which often hits the poor hardest. |
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A transfer
is a payment that is not made in exchange for anything. Basically, a
gift. You’re not getting a good
or service for it, and you’re not making it to be released from an
obligation, like with an interest payment on a loan. Sometimes you’ll see the words
“unrequited transfer” or “unilateral transfer” used
for this category. (For accounting
geeks: the transfer is actually the “offsetting entry” for the
payment, a sort of imaginary thing that the accountant imagines as whatever
the payment was made for.) “Current
transfers” are transfers that “directly
affect the level of disposable income of the ... donor or recipient.”
in the words of the European
Central Bank. The New
Zealand Central Bank says:
“Current transfers directly
affect the level of disposable income and influence the consumption of goods
and services for the donor and the recipient economies. Capital
transfers consist of the transfer of ownership of a fixed
asset, the forgiveness of a liability, and the transfer of cash that is
linked to, or conditional on, the acquisition or disposal of a fixed asset.
The transfers made by migrants as they move to a new country are an example
of a capital transfer.” In some presentations of the data, transfers are
divided into “official transfers” and “private
transfers.” Official transfers are
government-to-government payments, though some may go through international
agencies like the United Nations. This can be termed "aid" of various
kinds; when the Private (i.e. made at individual
initiative) transfers are made by workers who go abroad and send part of
their earnings home, e.g. Salvadorans in the U.S., Turks in Germany,
Filipinos in Singapore. So you would
expect the |
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Current Transfers, n.i.e.: Credit (Inflows) Official
Transfers into our country mean that foreign governments (or multilateral
agencies) make payments to us. Private
Transfers into our country mean that foreigners make payments to us. (Suppose
your uncle in (+) They require that foreigners make
payments to us so they take a plus
sign. Macro note:
Large incoming transfers will enable a country to import more -- in fact
that’s often the intent of foreign aid, and many countries insist that
their "aid" be spent on their exports, and the |
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Current Transfers: Debit
(Outflows) Official
Transfers to other countries are simply payments by our government to other
countries. Private
Transfers to other countries are simply payments to people in those
countries. Suppose you help support your grandparents in (-) They require that we make payments to
foreigners so they take a minus sign.
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Total
Current Account, n.i.e. You add up everything
above. (N.i.e.
means “not including exceptional financing.” Don’t worry about it.) |
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Financial
Account “The
financial account covers all transactions, including the creation and liquidation
of financial claims, associated with change of ownership in international
financial assets and liabilities.” (Central
Bank of New Zealand) |
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See my note at the top on the potential for confusion around the
term “Capital Account,”
which means different things to different people. In the IMF’s
presentation, “capital account” is mainly capital transfers, which means unrequited transfers of an asset
of some kind. See my note above under
“current transfers.” In
the World Bank's definition, “capital account includes
government debt forgiveness, investment grants in cash or in kind by a
government entity, and taxes on capital transfers. Also included are
migrants' capital transfers and debt forgiveness and investment grants by
nongovernmental entities.”
So basically you have both private capital transfers and public
capital transfers. For most countries this category will be extremely small,
if they are reported at all, so it’s highly unlikely that these will be
important for any of your research memos. |
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Capital
Account, n.i.e.: Credit |
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Capital
Account: Debit |
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Direct
Investment means
acquiring a significant ownership stake in a foreign business. “Direct
investment is investment undertaken by an entity resident in
one economy in an enterprise resident in
another economy. The purpose of the investment is to obtain or sustain a
lasting interest in the enterprise and exercise a significant degree of
influence in its management.” (Central
Bank of New Zealand) According to the IMF’s
current criteria, owning ten percent or more of a business qualifies as
having a “lasting interest” and “a
significant degree of influence in its management” If you own less than ten percent,
you’re treated as a portfolio investor.
Direct Investment is divided directionally: foreigners investing in businesses in our country,
and our residents investing in businesses abroad. |
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Direct Investment
Abroad Our residents buying (or selling) ownership stake
in foreign businesses in other countries.
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Direct Investment in
Reporting Economy, n.i.e. Foreigners buying (or selling) ownership stake in
businesses in our country.
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Think of portfolio investment as the kind of
securities that small investors might acquire: stocks, corporate or
government bonds. You’re
acquiring these as part of a portfolio of assets, but you’re not
buying enough shares in a company to have a significant ownership stake, in
particular the kind of stake that would give you a say in management. “Portfolio
investment consists of equity and debt securities that are
not classified to either direct investment or
reserve assets.
Equity securities include
shares, stocks, ... or similar documents that
usually denote ownership of equity. The level of equity ownership that
denotes portfolio investment is
taken as being less than 10 percent ownership in an entity. ... Debt
securities include tradable instruments such as bonds and
notes, debentures (long-term instruments) and money market instruments
(short-term instruments such as treasury bills, commercial and financial
paper).” (Central
Bank of New Zealand) Portfolio Investment is divided directionally: foreigners investing
in businesses in our country, and our residents investing in businesses
abroad. |
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Portfolio Investment
Assets Our residents’ portfolio investment
abroad.
Because those securities are our assets and their
liabilities, they’re called assets here. |
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Portfolio Investment
Liabilities, n.i.e. Foreigners’ portfolio investment in our
country.
Because these securities are our liabilities and
their assets, they’re called liabilities here. |
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The IMF says: “Financial derivatives are
financial instruments that are linked to a specific financial instrument or
indicator or commodity, and through which specific financial risks can be traded
in financial markets in their own right.” Basically, they are a category of more
complex financial instruments, and they are often individually tailored to
the needs of particular borrowers or lenders.
For the most part, however, it’s unlikely that you will have
much data for this category. |
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Financial
Derivatives Assets Our residents’ purchases or sales of
financial derivatives abroad. |
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Financial
Derivatives Liabilities Foreign residents’ purchases or sales of financial
derivatives in our country. |
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The major component in “Other
investment” is usually bank loans – specifically, the principal
of loans. The interest goes under
“income” in the current account. “The
other investment item is a residual category that includes all financial
transactions not covered under direct investment, portfolio investment,
financial derivatives or reserve assets ... Other investment can be further
subdivided into (i) trade credits, (ii)
loans/currency and deposits and (iii) other assets/other liabilities.”
(European
Central Bank) |
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Other Investment Assets Assuming this is bank lending, this would consist
of our banks making loans to foreigners.
The loan is our bank’s asset and the
foreigner’s liability. |
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Other Investment
Liabilities, n.i.e. Assuming this is bank lending, this would consist
of our foreign banks making loans to anyone in our country.
The loan is our liability and the
foreigner’s asset. |
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Total
Financial Account, n.i.e. Add all the Financial
Account items up. |
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The
Current Account plus Financial Account plus Reserve Changes should sum to
zero, because they should capture the totality of all transactions across our
borders. If they don’t,
somebody missed counting something. This may mean smuggling of goods in
or out. Sometimes a large negative figure will indicate capital flight
-- a lot of domestic residents buying foreign assets without telling their
government. |
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Net Errors
and Omissions |
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Overall Balance is
Current Account plus Financial Account plus net Errors and Omissions |
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Overall
Balance |
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Finally
we get to changes in the quantity of foreign assets held by the Central
Bank. What’s left
over after we sum up the Current Account and Financial Account should be the
change in the reserves held by the Central Bank. If
all these activities bring in more foreign exchange than they use, the
balance should be accounted for by additional foreign assets held by the
central bank. We call these assets reserves, so total reserves rise. If all
these activities use up more foreign exchange than they bring in, the Central
Bank has to fill the gap by selling some of the foreign assets it owns, so
total reserves fall. So: Current Account
+ Financial Account = Change in Reserves This is a useful
way to look at it because using the reserves is a policy choice made by the
government. Reserves can be seen as a "savings account" or
"war chest" (sometimes literally) of a government; it can spend
accumulated reserves to but things abroad that it needs. For example if the
harvest of a key export crop is bad, a government can dip into its reserves
to maintain imports of essential goods. Plus and minus
signs: This is a rich source of confusion. By accounting convention,
the reserve account is treated as a stash of assets outside the country that
you either spend money on (when you increase reserves) or draw money from
(when you sell some of those assets, thereby running down your
reserves). That means that when reserves rise, they are a net use
of funds (you're spending money to buy reserves, just like you spend money to
buy imports) and take a minus sign. And when you draw on
your reserves they are a net source of funds, and take a plus
sign. Got that? Trouble is, it's
counterintuitive because the minus sign corresponds to a situation when
reserves rise, and the plus sign corresponds to a situation when reserves
fall. We're so used to thinking "plus sign good" that it's
hard to wrap the brain around the fact that a big positive number in
"changes in reserves" means your country is burning through its
precious stash of reserve assets at a perilous rate. One
way to reduce cognitive dissonance is to look at "Overall balance" on the spreadsheet just above. A big negative
number means reserves were used up that year, a big positive number means
there was money left over to buy more reserve assets. |
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Reserves
and Related Items |
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Reserve
Assets This is the standard reserves. |
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Use of
Fund Credit and Loans If the country drew on IMF assistance, it will
show up here. |
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Exceptional
Financing |
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