Page 205 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes 12.1 Introduction to BOP and Types of Accounts

The BOP is divided into three different accounts:

The Current Account

The current account records the net flow of goods, services and unilateral transfers, or in other
words, gifts. This includes inflows and outflows of items such as tourism, transportation, military
expenditures and investment income. The nature of this account is reflected by its name, i.e., the
BOP resulting from activity during the period under consideration.
The Capital Account

The capital account records the net flow of FDI in plant, equipment and long-term, short-term
portfolio (debt and equity) investment. FDI are those investments in which management control
of the asset is retained. An investment by a firm into a subsidiary operation overseas, which the
parent firm controls, would be considered a transaction in this category. Long-term investments
are those having a maturity time of greater than one year. Likewise, short-term investments are
those having a maturity of less than one year. Additionally, the borrowings and lendings of
government are included in the capital account.

The Official Reserve Account (ORA)

The ORA measures changes in the holdings of foreign currency, SDRs and gold by the central
bank of a nation. It takes into account the surplus or deficit resulting from the current account
and capital account transactions.

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Caution In the accounting format, balances on individual accounts can be worked out as
follows:

(a) Trade balance (merchandise A/c) = Merchandise exports - merchandise imports
(X - M).
(b) Current account (includes earnings and expenditure for services and “invisible”
trade items).
= Balance on goods, services and income + Unrequired transfers (determined
autonomously because of pricing, quality of similar factors).
(c) Basic balance = Current A/c + long-term capital flows including FDI (autonomous).
(d) Overall balance/Official settlement balance
= Basic balance + Short-term capital movements + Errors and omissions.

The transactions in the current account, capital account and statistical discrepancies are treated as
autonomous in BOP accounting format whereas, entries in the official settlement account are
treated as compensatory items.

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