Overview of Balance of Payments (BOP)

The BOP is a record of all the international transactions between the residents of a country and the rest of the world over a period of time. It records all the money flows between the economy and the rest of the world.

The BOP is made up of the 2 Main accounts

Current Account (CA) and the Capital and Financial account (KFA).

Current Account (CA)

The CA is the part of the BOP which records exports and imports of goods and services, income flows and current transfers. 

The CA balance is the sum of the goods and services balance, the income balance and the current transfers balance.

• Goods & Services Balance

Known as the balance of trade in goods and services. (Export Revenue - Import Expenditure)

Usually the largest component of the CA.

• Net Income or Income Account

The primary income balance, which is also simply known as the income balance, is the inward income flows minus the outward income flows. Income refers to wages, rent, interest and profits. 

For example, Microsoft in Singapore repatriating its profits back to Home Country, the United States.

• Net Transfers or Current Transfers

Current transfers are government contributions to and receipts from other economies and international transfers of money by private individuals and firms, whereby no goods or services are rendered for. 

Foreign Aid or gifts is an example.

Capital and Financial Account

The capital and financial account is made of the capital account and the financial account. 

The capital account records capital transfers such as the acquisition and disposal of non-produced, non-financial assets such as land, patents, copyrights and franchises, etc. It is not important for your exam purposes!

The financial account is the part of the balance of payments which records changes in the holdings of shares, government securities, corporate bonds, deposits, loans, official reserves, etc. The financial account balance is the sum of direct investment (net), portfolio investment (net) and official reserves (net).

• Direct Investment

Direct investment refers to investment made with the objective of obtaining a lasting interest in an organisation and exercising a significant degree of influence in its management. Involve Foreign Direct Investment inflows and Direct Investment Abroad (outflows by local firms).

• Portfolio Investment

Portfolio investment refers to investment in financial assets such as stocks, shares and bonds (SSB). It also includes short-term investments such as hot money deposits.

• Official Reserve Account

Official reserves transactions are related to the central bank. Reserve assets refer to the central bank’s holdings of foreign exchange reserves, gold, Special Drawing Rights and reserves with the International Monetary Fund. Reserve assets (net) are the change in reserve assets.

Note: In some countries such as the United Kingdom, the change in reserve assets is recorded in the financial account which is the case presented in this book. However, in Singapore and some other countries, the change in reserve assets is recorded separately in the reserve assets account which is also known as the official financing account.

Note: By design, the balance of payments which is the current account balance minus the capital and financial account balance is equal to zero. 

Net Errors and Omissions

Errors and omissions are bound to occur in the process of constructing the balance of payments as the data for the current account and the capital and financial account are obtained from diverse sources. Since errors and omissions always occur, the current account balance minus the capital and financial account balance is not equal to zero. Rather, it is the current account balance minus the capital and financial account balance plus an imputed net errors and omissions which is equal to zero.

Question: If BOP is supposed to talk to zero, why would there be BOP Surplus or Deficit? 

Answer: When referring to BOP Surplus or deficit, we ignore the official reserve account. When the total currency flow is positive, the balance of payments is in surplus and that occurs when money inflows exceed money outflows. When the total currency flow is negative, the balance of payments is in deficit and that occurs when money outflows exceed money inflows.

Concise Notes like those below are only available to students of our economics tuition programme for JC A Level and IB Economics.

Notes on Persistent Balance of Trade Deficit

Notes on Persistent Balance of Trade Surplus