22. The balance of payments

What are the three main parts of the balance of payments?

The Current Account, The Capital Account, The Financial Account.

What is the current account?

• A record of all payments for trade in goods and services plus income flow.

What 4 parts is the CA separated into?

1. Balance of trade in goods (visibles)

2. Balance of trade in services (invisibles)

3. Net primary income (interest, profits, dividends and migrant remittances)

4. Net secondary income (transfers i.e. contributions to EU, military aid, overseas aid)

What component of the Current Account records international payments for goods/services?

Balance of trade in goods (visibles) and balance of trade in services (invisibles).

What is a Current Account Surplus?

currency inflows exceed outflows

What is a Current Account Deficit? (Typically leads to borrowing from other countries)

currency outflows exceed inflows

Which part of the balance of payments is the most important?

The Current Account (reflects a country’s international competitiveness)

How does FDI (Foreign Direct Investment) benefit the UK accounts?

Inward investment from overseas businesses, such as building manufacturing facilities in the UK, is a positive for the accounts.

What happens to a country's balance of payments if it heavily invests overseas?

negative impact on the Financial Account

What is the Capital Account ?

Transfers of funds associated with buying fixed assets (doesn’t not affect economic output)

What does the capital account involve?

➔ Sale of patents, copyrights, franchises, leases and other transferable contracts (example would be international buying and selling of land by businesses)

➔ Debt forgiveness/cancellation (forgiving debt counted as a negative)

➔ Capital transfers of ownership of fixed assets (i.e. international death duties)

What is the significance of the balancing item in the Balance of Payments accounts?

offsets discrepancies between payments in and annual income that should balance.

What does the Financial Account record?

• All transactions for financial investments

• changes of ownership of financial assets between residents and non-residents.

What does the financial account involve?

➔ Net balance of foreign direct investment flows (FDI)

➔ Net balance of portfolio investment flows (e.g. inflows/outflows of debt and equity)

➔ Balance of banking flows (e.g. hot money flowing in/out of banking system)

➔ Changes to the value of reserves of gold and foreign currency

What is a portfolio investment? Give an example.

• when people / businesses from one country buy shares/bonds in other nations.

• For example:

➔ A UK investor might buy some shares in Google (portfolio investment outflow for the UK)

What is a balancing item? When is it used?

• used when preparing accounts to cover up imbalances between two figures which should balance.

  ➔ Often when preparing accounts there are slight discrepancies between payments in and annual income.

• used to offset the difference without having to alter the initial calculations