Balance of Payments reveals the various aspects of the country’s international economic position. It presents international financial position of a particular country.
It helps the government to take decisions on monetary and the fiscal policies at hand and on the external trade and payments issues on other.
In the case of the developing country, the balance of payments shows extent of dependence of country’s economic development on financial assistance by developed countries.
The current account is made up of the following components:
Trade in goods: items include imports and exports of the finished goods, such as the cars, and computers.
Trade in services: include the financial services, tourism, and consultancy.
Income from the investment and employment: Investment income refers to income made from investing abroad and it includes profits, such as those from the business activities of the subsidiaries located abroad
The payments to individuals who are the residents of a country, and they are employed in another, are also included in current account.
Transfers: Is the final section of the current account and it includes transfer payments arising from the gifts between the residents of different countries, the donations to charities abroad, and the overseas aid.
The capital accounts
The Capital and the Financial Account records flows of capital and the finance between the UK and the rest of the world. The flows include:
1. Real foreign direct investment (FDI), such as the UK firm establishing the manufacturing facility in China. Direct investment refers to the investment in the enterprise where the owners or the shareholders have some element of control of the business.
2. Portfolio investment, such as the UK investor buying shares in existing business abroad.
3. Financial derivatives are the financial instrument whose underlying value is based on the other assets, such as the foreign currency, interest rates, commodities or the indices.
4. Reserve assets are the foreign financial assets which are controlled by the monetary authorities
A balance of payments deficit means that the country imports more goods, services and the capital than it is able to exports. It must borrow from the other countries to pay for the imports. In the short-term, this fuels the country’s economic growth.