Understanding Balance of Payment terms

BOP consist of two accounts
1.Current Account
2.Capital Account


The Current accounts which measures the net balances in
1. Trade in goods
2. Trade in Services
3. Investments income from overseas assets
4. Transfers (private and government) between counties
The Capital account measures the net flows of capital between the nations
1. Direct Capital Investment including FDI (Inflow of Capital spending by foreign firms, Take overs of domestic business by foreign owned business)
2. Financial Investment Flows ( Inflow of money from overseas into Government bonds and Securities)
3. Banking flows

In principle a country running a current account deficit can ‘balance’ things up by running a surplus on the capital account - the UK is a good example, because the economy has been a favoured location for FDI and there is a strong appetite among foreign investors for UK government bonds
A country running a current account surplus can run capital account deficits i.e. invest heavily overseas or just accumulate foreign exxchange reserves e.g. China, Norway, Oil exporting nations .... some of whom have created their own sovereign wealth funds
In principle the BoP must balance .... it does so because of adjustments that countries make to their foreign exchange reserves using IMF agreed accounting measures and also because of the balancing item which reflects errors and ommissions!