The Balance of Payments (BOP) is a method countries use to measure the flow of money into and out of their economies over a specific period of time, usually quarterly and yearly. The BOP summarizes the total international trade activities of the private and public sectors by monitoring the payments and liabilities to foreigners (debits) and receipts and obligations from foreigners (credits).

If a country's debits are greater than its credits over the given period, then it can be said to be running a deficit, that is, money is tending to flow out of the economy. Conversely, if the country's credits are greater than its debits, then the country can be said to be running a surplus, where money is tending to enter the economy.

In the simplest of senses, the balance of payments is divided into two accounts - the current account and the capital account. The current account measures mainly the net flow of goods and services into the country.

The trade balance, as this flow is commonly known, is the sum of total exports less total imports in tangible goods such as bauxite, motor vehicles or food, and the sum of total exports less total imports in services such as tourism, transport, insurance, education and so forth. Although the trade balance is typically its largest component, the current account also includes net international interest payments and net unilateral transfers such as remittances and foreign aid.

As its name suggests, the capital account keeps track of capital flows in and out of the country. Basically, it measures the relative change in foreign ownership of domestic assets (inflows) as opposed to domestic ownership of foreign assets (outflows). A capital account can be said to be in surplus where foreign ownership of domestic assets is greater than domestic ownership of foreign assets, and in deficit in the opposite situation. The capital account takes into consideration investment in real estate, bonds, stocks, foreign direct investment and government-owned assets such as foreign reserves, gold and IMF Special Drawing Rights.

Simple theory
According to simple theory, a country's payments should balance, hence the term 'Balance' of Payments'. The basic underlying principle of this theory is that a country cannot consume more than it produces unless it borrows from abroad. According to the balance theory, a current account deficit, that is, a scenario where total imports are of greater value than total exports, should be compensated for by a capital account surplus.

This capital account surplus could result from increased foreign direct investment, reduction of foreign currency reserves (increasing reserves of local currency) and sale of securities on the international markets by the government, or capital inflows drawn by attractive domestic interest rates. In a case where total capital outflows are greater than total capital inflows, that is, a capital account deficit, one would expect a current account surplus, as the increased domestic investment overseas must be funded by some combination of sales of goods and services to foreigners (positive trade balance), income from interest and/or dividend payments from abroad, foreign grants, foreign aid and so forth.

Jamaica perspective
A recent news release from the Bank of Jamaica regarding the country's balance of payments illustrates these concepts quite clearly. It states that for the period January to November 2006, Jamaica's current account deficit increased by an estimated US$59.3 million over the comparable period in 2005. This increase was attributed to a significant increase in the goods account deficit, resulting primarily from expansions in payments for fuel, machinery and transport equipment, in spite of increased export earnings.

The overall current account deficit was, however, partially offset by increasing surpluses in the service and current transfers accounts resulting from increased tourist arrivals and spending, and growth of net private remittance flows respectively. The balance is seen in the activity of the capital account. The central bank stated that net official and private investment inflows were more than sufficient to finance the current account's deficit. That said, the bank's foreign reserves (a capital outflow) increased to offset the extra capital inflows.

David Hayle is a junior trader with Sterling Asset Management Ltd. Sterling provides medium to-long-term financial advice and instruments in US and other world market currencies to the corporate, individual and institutional investors.
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