How do you record international transactions with balance of payments accounts?

1 The balance of payments framework

The balance of payments accounts are divided into two main categories: the current account and the capital account. The current account records the transactions that affect the income and consumption of a country, such as exports and imports of goods and services, net income from abroad, and net transfers. The capital account records the transactions that affect the ownership and accumulation of assets and liabilities, such as foreign direct investment, portfolio investment, and other financial flows. The sum of the current account and the capital account is called the financial account.

2 The double-entry system

To record international transactions with balance of payments accounts, you need to use the double-entry system. This means that every transaction has two entries: a credit and a debit. A credit is a transaction that increases the net foreign assets of a country, such as an export of goods or an inflow of capital. A debit is a transaction that decreases the net foreign assets of a country, such as an import of goods or an outflow of capital. The total credits and debits must balance each other, so that the balance of payments is zero.

3 The balance of payments identity

The balance of payments identity is a simple equation that shows the relationship between the current account, the capital account, and the official reserves account. The official reserves account records the changes in the central bank's holdings of foreign currency and gold. The equation is:

Current account + Capital account + Official reserves account = 0

This means that any surplus or deficit in the current account or the capital account must be offset by a change in the official reserves account. For example, if a country has a current account deficit, it means that it spends more on imports than it earns from exports. To finance this deficit, it must either borrow from abroad (capital account surplus) or sell its foreign reserves (official reserves account deficit).

4 The balance of payments adjustment

The balance of payments adjustment refers to the process by which a country restores its balance of payments equilibrium. This can happen through changes in the exchange rate, the income level, the interest rate, or the government policies. For example, if a country has a current account deficit, it may experience a depreciation of its currency, which makes its exports cheaper and its imports more expensive. This will improve its trade balance and reduce its current account deficit. Alternatively, it may experience a fall in its income level, which reduces its demand for imports. This will also improve its current account deficit.

5 The balance of payments analysis

The balance of payments analysis is a useful tool for understanding the economic performance and challenges of a country. It can reveal the sources and uses of foreign exchange, the sustainability of external debt, the vulnerability to external shocks, and the effectiveness of policy interventions. For example, a country with a persistent current account deficit may face the risk of a balance of payments crisis, which occurs when it cannot meet its external obligations. To prevent or resolve such a crisis, it may need to adopt policies that reduce its spending, increase its saving, promote its exports, or attract foreign capital.

6 Here’s what else to consider

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