(a) Define the term Balance of Payments. (b) What are its main components?

Answer Details

(a) Balance of Payments (BOP) is a systematic record of all economic and financial transactions between the residents of a country and the rest of the world over a given period, usually one year. It shows total receipts (inflows) against total payments (outflows) of foreign exchange.

(b) Main components.

1. Current account: records trade in goods and services and income flows. It contains:
   • the visible trade (merchandise) account, the export and import of physical goods, giving the balance of trade;
   • the invisible trade account, the export and import of services such as banking, insurance, shipping and tourism;
   • income and current transfers, such as interest, dividends, remittances and gifts.
2. Capital and financial account: records international movements of capital, such as foreign direct investment, portfolio investment, loans and the purchase or sale of assets.
3. Official reserves (monetary movements): records changes in the country's external reserves and transactions with bodies such as the IMF, used to balance any surplus or deficit on the other accounts.

By definition the overall balance of payments always balances because any deficit or surplus on current and capital accounts is offset by movements in official reserves.