4.6 Balance of payments

The balance of payments records transactions between residents and the rest of the world. The current account covers trade in goods and services, primary income and secondary income; the capital and financial accounts record transfers of capital and changes in financial assets and liabilities.

Because each transaction is recorded twice, the accounts balance in accounting terms. A current-account deficit therefore has a counterpart in capital or financial flows, reserve changes or both; it is not the same as a government budget deficit.

A credit records a receipt from abroad or increase in external liabilities; a debit records a payment abroad or acquisition of external assets. For each account, calculate $\text{balance}=\text{credits}-\text{debits}$: a positive result is a surplus and a negative result a deficit. Example: exports of 120, imports of 150, net income of -10 and net current transfers of +5 give current-account balance $120-150-10+5=-35$, a deficit of 35 currency units. Keep the sign convention and period explicit.

The current account shows whether exports and income received exceed imports and income paid. The financial account records flows such as direct investment, portfolio investment and reserve assets; the capital account is smaller but still part of the accounting structure.

Classify a transaction by asking what is being exchanged: a good or service, an income payment, a transfer, or ownership of a financial asset. Do not treat every capital inflow as export revenue.

Use the full classification: current account = trade in goods + trade in services + income + current transfers; capital account = capital transfers + transactions in non-produced, non-financial assets; financial account = FDI + portfolio investment + reserve assets + official borrowing. A dividend received from abroad is current-account income, purchase of a foreign company is outward FDI, a patent sale is a non-produced non-financial asset transaction, and a central-bank reserve change belongs to the financial account.

A current-account deficit can be financed by borrowing from abroad or selling domestic assets, while a surplus can fund investment abroad or add to reserves. The accounts are interdependent because the external position changes both spending flows and the claims held by foreigners.

The same financing flow can have different implications: foreign direct investment may build productive capacity, whereas short-term portfolio flows can reverse quickly. Trace the identity first, then evaluate sustainability.