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Home Field Trips Trade Tour Interpreting the Balance of Payments

Theories

Interpreting the Balance of Payments

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The Balance of Payments is part of the national accounts which records payments to, and receipts from the rest of the world. The account is made up of three sections. These record details of inflows and outflows of foreign exchange.

• the current account : inflows and outflows generated by international trade
• the capital account :inflows and outflows resulting from the movement of capital and money
• financing: inflows and outflows that enable the balance of payments to balance

Balance of Payments on Current Account

This includes all the payments made and receipts earned that result from trade. Hence this part of the accounts allows us to judge the international competitiveness of a country. When Zambia exports copper to another country it generates a flow of foreign exchange into Zambia and out of the other country.

If exports are greater than imports i.e. inflows of funds are greater than outflows of funds then there is a Balance of Payments surplus on current account. If imports are greater than exports i.e. outflows of funds are greater than inflows of funds then there is a Balance of Payments deficit on current account. In the accounts, outflows of foreign currency are denoted with a minus sign.

The Balance of Payments on Current Account are broken down into:

• the Balance of Trade or the Visible Balance which measures the net flow of funds resulting from trade in goods. If the value is positive then there is an overall inflow of foreign exchange. If negative there is an overall outflow of foreign exchange.
• The balance of invisible trade measures the net flow of funds resulting from the trade of services. This balance of invisible trade will include all of the following inflows or outflows of funds:
  • flows resulting from financial services e.g. banking , insurance , brokerage firms
  • flows from shipping and aviation services
  • expenditure by foreign government on embassies and military bases
  • flows from tourist services
  • gifts of money from overseas residents to domestic residents
  • net property income from or paid abroad
  • payments of interest on official debt.

By looking to see if the value of the account item is positive or negative indicates whether there is an inward or outward flow. However, there are many other flows of foreign exchange taking place unrelated directly to trade. These are recorded in the capital account.

The Capital Account

The capital account records inflows and outflows of foreign exchange that result from capital flows. In the case of Zambia the capital account will include flows resulting from:

• repaying of debt to foreign commercial banks, foreign governments and multinational agencies such as the IMF. This is referred to as amortization
• borrowing from foreign governments and foreign commercial banks
• flows of aid into the country from overseas agencies
• flows of foreign direct investment such as investment by multinational corporations
• resident capital outflow or capital flight as a country's citizens send money out of the country into foreign banks, or to purchase foreign property or financial assets.

In addition an outflow of funds occurs where a Zambian resident or firm acquires capital or financial assets in another country. An inflow occurs where a foreign resident from another country acquires capital or financial assets in Zambia.

The Overall Balance and the Need for Financing

The current account and the capital account are added to obtain the overall balance of payments. Once again the sign will determine whether there is an overall inflow or outflow.

As the name suggests the balance of payments must, by definition, balance. As it is the inflows of foreign exchange that ultimately enable subsequent outflows to occur there must be some way of ensuring that the inflows of funds always equals the outflow of funds. Indeed, if it looks as though there is going to be an imbalance and inflows are less that the outflows, the government or its agent the Central Bank may resort to a number of ways of generating additional inflows of funds. This is referred to Financing. These can be referred to accommodating flows.

In the case of Zambia the data shows that the country regularly experiences a balance of payments deficits and needs to generate an inflow to finance it. Normally there are a number of financing options open to countries in this situation.

• Use up reserves of foreign currencies held at the Central Bank.
• Borrow from foreign central or commercial banks
• Borrow from organisations such as the International Monetary Fund
• Reschedule its debt or having its debt reduced

Next theory - Introduction to Exchange Rates >>

Related Glossary Items:
IMF
Current Account Balance
Balance of Trade
Balance of Payments
Current Account
Capital Account
Amortization
Foreign Direct Investment

Related Issues:
Zambia's Exports and Imports
Zambia's Balance of Payments Situation
Zambia's Trade Policy

Related Theories:
Balance of Payments Policies
Terms of Trade