Balance of Payments (Current Account, Financial account and Capital Account)

Question 1

What is the Balance of Payments (BOP)?

Answer 1

A record of all financial transactions made between residents of one country and the rest of the world over a period of time.

Question 2

What are the three main components of the BOP?

Answer 2

1️⃣ Current Account (goods, services, income, transfers)
2️⃣ Capital Account (minor asset/transfer flows)
3️⃣ Financial Account (main investment flows)

Question 3

What is the Capital Account?

Answer 3

A relatively small part of the BOP. Records transfers of non‑financial, non‑produced assets and capital transfers.

Question 4

What does the Capital Account measure?

Answer 4

• Debt forgiveness
• Inheritance taxes paid internationally
• Death duties
• Sales of tangible assets (e.g. buildings)
• Sales of intangible assets (e.g. patents, copyrights)
• Transfers of assets by migrants

Question 5

What is the Financial Account?

Answer 5

Records transactions involving the purchase or sale of financial assets across borders. This includes FDI, portfolio investment, and reserves.

Question 6

3 key components of the Financial Account

Answer 6

i) Foreign Direct Investment (FDI)
ii) Portfolio Investment
iii) Reserve Assets

Question 7

Foreign Direct Investment (FDI)

Answer 7

Long-term investment in physical assets: e.g. German car firm sets up factory in UK (inflow); UK firm builds in India (outflow).

Question 8

Portfolio Investment

Answer 8

Buying or selling foreign financial assets: e.g. bonds, stocks, derivatives.
UK pension fund buys US shares = outflow.

Question 9

Reserve Assets

Answer 9

Central bank holdings of foreign currencies, gold, SDRs. Used to stabilise exchange rates or settle international debts.

Question 10

What does a financial account surplus mean?

Answer 10

A country is receiving more investment inflows than outflows — e.g. strong FDI or foreign investors buying domestic bonds/stocks.

Question 11

How is a current account deficit financed?

Answer 11

Through net inflows in the financial account — borrowing, FDI, or selling domestic assets to foreign investors.

Question 12

BOP identity equation

Answer 12

Current Account + Capital Account + Financial Account = 0
(plus balancing item for errors/omissions)

Question 13

Why must the BOP always balance?

Answer 13

Because any money flowing out must be matched by a financial or capital inflow, or vice versa. It’s an accounting identity.