The Balance of Payments is a complicated international economic formula used to understand all of the transactions that a country conducts with those in another country. The transactions include everything that is undertaken by that country’s people, companies and government bodies and consists of all imports and exports. Goods, services and capital are included in these transactions, in addition to foreign aid or remittances.
The balance of payments, also known as the balance of international payments, represents the difference in value between payments into and out of a country over a specific period.
If all transactions between the two countries are properly included, then the payments and receipts between the two countries will be equal. For example, if a country exports an item, then it technically imports foreign capital as payment for the item exported. However, sometimes a country cannot fund its purchases and ends up dipping into its reserves to make payments. When this happens, the country has a Balance of Payment deficit. Statistical discrepancies often occur as it’s difficult to account for every transaction between two countries accurately.
To calculate the BOP of a country, you need to review three main accounts: the current account, the capital account and the financial account. Each of these accounts contains inflows and outflows. The current account includes merchandise trade goods, services, income receipts and one-way foreign transfers. Transfers of financial assets, including tax payments and transfers of titles to assets, are included in the capital account. The financial account includes stocks, bonds, commodities and real estate. Sometimes, the capital account and the financial account are looked at together as one entity because they both include financial transactions.
To calculate the BOP, you need to calculate the sum of the country’s exports and imports. Exports are written as a credit entry while imports are written as a debit entry. For example, if a country has exports of $400 million and imports of minus $500 million, then they have a trade deficit of $100 million, or a BOP of minus $100 million. If the numbers were reversed and the number of exports exceeded the number of imports, then the country would have a trade surplus.
The BOP helps economists evaluate the strength of a country’s economy in comparison to the economies of other countries. When a country has a deficit, they are technically borrowing money to purchase goods and services from the rest of the world. However, if they have a surplus, they are in a better financial position and can afford to import additional goods and services. Imbalances in the BOP can create political tensions between countries and disrupt the world’s political climate.