4.6.2 Components of the balance of payments Notes

The balance of payments has three components:

1. Current account
2. Capital account
3. Financial account

Calculation: Elements of Balance of Payments

This table below will be utilised throughout the explanation of all components.

Current Account

Balance of trade in goods

1. Exports are the goods produced domestically in Country A and sold to foreign countries.
   1. The payment for these exports are received in the exporting country's currency.
   2. Hence, exports are considered to be credit as it is the inflow of money.
2. Meanwhile, imports are the goods produced in foreign countries which are purchased by Country A.
   1. The payment for these imports are made in the country's currency Country A imports from (increasing supply of Country A's currency).
   2. Hence, imports are considered to be debit as it is the outflow of money.
3. Thereby, the balance of trade in goods can be calculated by:
   1. $\text{Balance of Trade in Goods} = \text{Export of Goods} - \text{Import of Goods}$

Balance of trade in services

The same applies for services.

1. Exports are the services created domestically in Country A and sold to foreigners.
   1. Services include tourism for foreign individuals, consulting, transportation, insurance, etc.
   2. When foreigners buy the following services, it is considered as the export of services.
   3. Hence, exports are considered to be credit as it is the inflow of money.
2. Meanwhile, imports are the services created in foreign countries which are purchased by Country A citizens.
   1. When Country A citizens purchase tourism packages or insurance from foreign firms, it is considered as the import of services.
   2. Hence, imports are considered to be debit as it is the outflow of money.
3. Thereby, the balance of trade in services can be calculated by:
   1. $\text{Balance of Trade in Services} = \text{Export of Services} - \text{Imports of Services}$

Balance of trade in goods & services

Often referred to as "Balance of Trade", it can be calculated by:

$\text{Balance of Trade} = \text{Balance of Trade in Goods} + \text{Balance of Trade in Services}$

Income

Income is considered to be all the inflows and outflows of factor incomes: wages, interest, rent, and profits.

1. Credits are inflows from foreign investments.
   1. This could also refer to Country A's citizens who might earn income from abroad such as having bank accounts which earn interest.
2. Debits are outflows to foreign investors.
   1. This could refer to Country A citizens who might need to pay rent for housing abroad.
3. Therefore, income is:
   1. $\text{Income} = \text{Inflow of Income} - \text{Outflow of Income}$

Current transfers

Current transfers are inflows and outflows of funds for which no goods or services are exchanged.

1. Credits are inflows from foreign aid, transfers from abroad such as remittances (money sent to close family in Country A from abroad) or gifts, and pensions.
2. Debits are outflows for aid or remittances sent abroad.
3. $\text{Current Transfers}$ $=$ $\text{Inflow into Country A}$ $-$ $\text{Outflow out of Country A}$

Balance on Current Account

1. Summing up the components mentioned above provides us the current account balance.
2. If there is a larger quantity of credits than debits, then Country A would have current account surplus.
3. If there is a larger quantity of debits than credits, then Country A would have current account deficit.

Capital Account

Capital Transfers

Capital transfers is the (inflows - outflows of) funds exchanged when an asset changes ownership from one party to another.

1. Examples of capital transfers include: debt forgiveness, investment grants (provided by governments), sale of fixed assets, etc.