Balance of Payments - Unit 2
The Current Account
The current account records flows from the exports and imports of goods and services as well as income flows and net transfers.
Net merchandise trade is found by calculating inflows and outflows of goods.
Net Invisable Trade or Net Services is found by calculating the inflows and outflows of services.
Net Income flows are found by calculating the inflows and outflows of interest, dividends, repatriated profits or other incomes.
Net Transfers can be calculated by recording any inflows or outflows of money without any return. For instance, sending money to family, foreign aid payments or contributions to the UN are all transfers.
Together, when added, these records make up the value of the current account. In 2021, the current account recorded a surplus of $20.5bn in Sep 2021 according to tradingeconomics.com. (https://tradingeconomics.com/australia/current-account)
The Capital and Financial Account
The capital and financial account records changes in foreign assets due to investment and borrowing overseas. The capital section of this account makes up the largest component, whereas the financial flows are very minimal.
Capital flows record any financial flows between Australia and the rest of the world that directly affect the level of assets or liabilities in Australia. An example of this includes purchases of foreign trademarks.
The Financial Account includes all foreign borrowing and international sale of assets. This investment can be divided into four categories: direct investment, portfolio, reserve bank flows and other forms of investment.
Types of Investment (Financial Account)
Direct Investment occurs when an investor owns more than 10% of a company and has a large degree of influence in business decisions. These are long term investments.
Portfolio investments are short term investments that include international equity and debt securities that make up less than 10% of the company.
Reserve Bank Flows are assets owned by the Reserve Bank of Australia. These include monetary gold, foreign exchange and Special Drawing Rights.
Other Investments are any investments that do not fall into the above categories. These include trade credits, loans or currency.
Relationship between the Current Account and the Capital and Financial Account
The balance of payments must BALANCE. This means that any value in the current account must be reflected in the capital and financial account. For instance, if the current account records a surplus of $20b then the capital and financial account will record a deficit of -$20b. For this reason, the accounts link with each other. The net-income sub-section of the current account reflects changes in the capital and financial account, as shown, an increase in foreign investment (financial account) will increase the deficit in the net income sub-section of the current account.
This is an important concept to understand as it is common for exam questions to ask you to explain the relationship between both accounts.