a.  Just like what the balance sheets do for the corporations, the balance of payments does for the economies.

b.  The balance of payments is a double-entry bookkeeping system that summarizes the country’s economic transactions with the rest of the world for a specific time period.

c.  The balance of payments also has two effects of a transaction, i.e. debit and credit for every single transaction.

d.  Following transactions that can be classified as debit entries:

     i.   increases in real assets,

    ii.  increases in financial assets, and

   iii.  decreases in financial liabilities.

e.  These transactions can be classified as the credit entries:

     i.  decreases in real assets,

    ii.  decreases in financial assets, and

    iii.  increases in financial liabilities.

f.  The real and financial assets and liabilities arising as a result of:

     i.  exports,

    ii.  imports,

   iii.  financial transactions, and

   iv.  transfer payments.

g.  The main components of the balance of payment account are:

     i.  Current Account: It measures the flow of goods and services in and out of an economy.

    ii.  Capital Account: It measures the flow of capital in and out of an economy.

   iii.  Financial Account: It records the investment flows in an economy.

h.  The balance of payment identity says that the total of the current account must equal the sum of totals of capital account and the financial account. That is:

It should be noted that all the three components of the balance of payments, i.e. a current account, capital account, and the financial account may have both debits and credit values within themselves, but the final total of the current account must equal the sum of totals of capital account and the financial account.

1.1.         Current Account

The current account consists of the following transactions:

a.  Merchandise Trade: It comprises all the commodities and manufactured goods that are bought, sold, or given away during the period.

b.  Services: The services include transactions related to tourism, healthcare, education, transportation, business services, fees on copyrights, patents, etc.

c.  Income Receipts: These include income such as dividends, interests, etc.

d.  Unilateral Transfers: These are the one-way transfer of assets such as foreign direct aid, income earned from abroad sent back home, etc. against which no benefit is provided to the transferor.

1.2.         Capital Account

The capital account consists of the following transactions:

a.  Capital Transfers: These include transfers such as migrants transfers, debt forgiveness, taxes on gifts or inheritances, duties on death, transfer of funds related to the sale or purchase of fixed assets, etc.

b.  Sale and Purchase of Non-Produced, Non-Financial Assets: These include transactions such as the sale or purchase of intangible assets, rights to natural resources, etc.

1.3.         Financial Account

The financial account can be broken down into two sectors:

a.  Financial Assets Held Abroad: These are the financial assets in the form of:

    i.  official reserve assets,

    ii.  government assets, or

   iii.  private assets

in the form of gold or foreign exchange securities, that are held abroad.

b.  Foreign-Owned Financial Assets Within the Country: These include foreign assets such as:

     i.  official assets such as bonds, stocks, etc.

    ii.  other foreign assets, such as direct investments, which cannot be classified as official assets.

1.4.         Final Balance of Payment Account

a.  If we recall the equation of national income, which is:

In this equation, the term X-M represents the current account balance, which measures the size and direction of the international borrowing or lending.

b.  If we rearrange the above equation, we can rewrite the same as:

We know that X-M equal the current account balance, therefore we can write the above equation as:

Now, if:

    i.  The current account balance is greater than zero, the economy must be lending abroad.

    ii.  And, if the current account balance is less than zero, it must be borrowing from abroad.

c.  Now, if we recall, the disposable income equals the national income minus the sum of taxes and transfer payments.

Also, disposable income equals consumption plus savings.

Now, we can rewrite the above equation as:

Substituting the value of disposable income from the first equation we get:

d.  Now, if we substitute the value of C derived above in the equation for CA, we get:

Solving the above equation, we get:

In the above equation, the term T-G-R (i.e. the taxes minus the government spending minus the transfer payments) is nothing but the government surplus (i.e. S_g).
Therefore, the above equation can be simplified as:

e.  Now we can rewrite the above equation and interpret the same as follows:

     i.  CA – I  = S_p + S_g

That is, the sum of private savings and government savings equals the current account balance plus the domestic investment.
Thus, if the current account balance is negative, domestic investment can be greater than private savings and government savings, and vice-versa.

    ii.  S_p = I + CA – S_g

Thus, w can say that private savings can be used for domestic investments, current accounts, or increase or decrease in the government debt.

   iii.  CA =  S_p – S_g – I

Thus current account can be negative if, either private and government savings are too low or the domestic investments are too high.