The balance of payments consists of a series of accounts that reflect the transactions made between an open economy and the rest of the world. As stated in the sixth edition of the Balance of Payments Manual, by the International Monetary Fund, “the balance of payments [is] a statement that summarizes economic transactions between residents and nonresidents during a specific time period”.
These international accounts, which grow greater every day thanks to globalization, are harmonized with the System of National Accounts, so comparisons can be made. They provide a broad view required for the analysis of international trade, exchange rate regimes, and the economic relation between countries, which may translate into vulnerabilities. Therefore, it is of great importance to understand them so business cycles can be anticipated and its consequences diminished.
The balance of payments “consists of the goods and services account, the primary income account, the secondary income account, the capital account, and the financial account”. The first three components form what is known as the current account balance, which mainly shows movements in goods and services and income derived form transactions related to these. The capital account is the sum of two accounts: capital transfers between residents and non-residents; and credit and debit entries for nonfinancial assets. Finally, the financial account shows net acquisitions and disposals of financial assets and liabilities.
The relationship between these accounts is shown in the following formula:
CAB + KAB = NFA
where
CAB = current account balance
KAB = capital account balance
NFA = net financial account
This must be understood as follows: the sum of the balances on the current and capital accounts represent the surplus(net lending) or deficit(net borrowing) that an economy has with the rest of the world. This is equal to the financial account, since it measures how the net lending or borrowing from non-resident is financed.