BALANCE
OF PAYMENTS
Definition
An open economy deals
with a great number of economic relations throughout
the world, some are commercial relations and some others
are financial relations. Thus, the balance of payments
summarizes all the different transactions between a
country and all other countries.
The balance of payments
is an accounting record of all economic transactions
between a country and other countries for a specific
time period, usually a year or even a quarter. The balance
of payments represents a systematic record of all payments
and liabilities to foreigners and all payments and obligations
received from foreigners, in dollars which is the currency
commonly used for transactions.
The transactions that imply capital outflows or payments
and liabilities to foreigners are called debits, which
are represented by a minus sign in the balance of payments.
For example: the imports, loans to other countries and
the expenditures made by national tourists in other
countries. On the other hand, credits are those payments
and obligations received from foreigners, such credits
are represented by a plus sign. For example, exports,
foreign loans, and foreign investment.
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Structure
of the balance of Payments
The most common structure
of the balance of payments is the one that divide it
into four accounts, which correspond to the nature of
their transactions.
1. Current
Account: the current account of the balance
of payments is subdivided into the following categories:
-
Balance
on Merchandise Trade: this balance reflects
all the imports and exports. It is the difference
in value between the total (FOB) exports and total
(CIF) imports of a country. A positive balance of
trade is known as a trade surplus and a negative
one is known as a trade deficit.
-
Balance
on services: the difference in value over
a period of time of a country's imports and exports
of services and payments of property incomes. For
example insurance, governmental services, travels
and transportation.
-
Unilateral
Transfers: are those transfers in which
one of the parties does not pay. In other words,
gifts and shipments that the residents of a country
send to another nation.
The current account is the sum of the sub-accounts
previously mentioned.
2. Capital
Account: this account basically deals with
the following transactions: foreign investments, short
and long term loans, amortization of foreign debts,
etc. These transactions can represent incomes or expenses
as payments are made or received. This account is subdivided
into two sub-accounts.
-
Private capital: this account includes
all the incomes and expenses of investments and
loans carried out by the private sector.
-
Official
Capital: it includes external debt movements,
in other words credits except amortization and interests.
There are other incomes of official capital which
correspond to investment in reserves and credits
granted.
The sum f this account represents the net -indebtedness
of a country.
3. Changes
in Official Reserve: official reserves are
the foreign assets held by central bank. Official reserves
include:
- Monetary gold.
- Currencies: bills of countries
that have strong and convertible currencies such
as the dollar and the yen.
- Deposits of national banks in
first-class foreign banks.
- Reserve position in the IMF.
- Special Drawing Rights.
- Assets of foreign governments
and financial institutions characterized by a high
liquidity and solvency.
Official Reserves
play a relevant role. That’s why economic authorities
seek to maintain an appropriate level of reserves. The
main functions of official reserves are:
- Reserve Ratio Requirement.
- A fund to pay any debit of the
balance of payments.
In other words, official
reserves assure the stability and convertibility of
national currency.
4.
Errors and Omissions: this account deals with
all the undetermined capital. In other words the errors
and omissions account simply balances the balance of
payments. Actually, the sum of the current account and
the capital account should equal the changes in official
reserve.
