Balance of payments (BOP): Definition, Components, Accounts & Formula

The structure and accounts of the balance of payments

The balance of payments structure has four components:

• Current account.
• Capital account.
• Foreign exchange reserves.
• Errors and omissions.

• Current account 

The current account records payments made for goods and services imported from abroad, income from exports of goods and services sold abroad, and also net transfers to or from abroad.

The balance of this account is equal to exports minus imports plus net interest and net transfers, if the balance is negative there is a deficit, if it’s positive there is a surplus.

Exports-Imports+net transfers.

• Capital account

The capital account records foreign investment and the loans received by a country, these are currencies that enter the country and have a positive sign. The capital account registers with a negative sign the investments and payments that a country makes abroad.

If the sum is negative, there is a deficit in the capital account, if the sum is positive, the country has a surplus in this account because it receives more resources abroad than the ones it takes abroad.

• Foreign exchange reserves

The foreign exchange reserves account records the official reserves, which is money kept in the form of foreign currency.  The possession of foreign currency is considered to me the same as to invest abroad and is a positive entry. A decrease in reserves is something positive, and an increase is negative.

• Errors and omissions

As its name indicates, it’s the record of errors and omissions in the balance of payments that may occur as a result of over invoicing, capital flight, etc. The sum of the previous three accounts is expected to be equal to zero, but when it’s not, those errors or differences go in this account.

Formula of balance of payments

To calculate the balance of payments, the formula is current account + capital account + financial account + balancing item = 0. (1)

Debtor nation and creditor nation

A debtor nation is a country that, over a period of time, has borrowed more from the rest of the world than the amount it has lent. A creditor nation is a country that has invested more in the rest of the world than what the countries have invested in that country, in other words, it’s when its assets abroad are greater than its debts.

A transaction that generates foreign currency into a country is a credit and is recorded as a positive entry. When the country must do a payment in foreign currency, it’s a debit and is recorded as a negative entry.

For example, Venezuela has a debit balance in 2014, 2015, 2016 and 2017, with -718, -4,051, -6,808, -490 and a credit balance in 2018, with 955. It was a debtor from 2015 to 2017 and a creditor in 2018.

Source: Central Bank of Venezuela.

Surplus and deficit in the balance of payments

A surplus occurs when a country exports exceed the imports, so the surplus says about the relationship of a country with the world. When the balance of payments is positive, it means that a country is capable of supplying itself and that its production is efficient.

The trade deficit is the opposite, and it consists of the situation in which exports exceed imports, and it means that the nation depends on foreign production and is something negative for any economy.

As explained before, a transaction that generates foreign currency into the country is a credit and is recorded as a positive entry, and when a foreign currency payment is required, it’s a debit and is recorded as a negative entry.

See more: Foreign Surplus and Deficit