UK Balance of Payments

The Balance of Payments is a record of a country’s transactions with the rest of the world. It shows the receipts from trade. It consists of the current and financial account

1. Current account

This is a record of all payments for trade in goods and services plus income flow it is divided into four parts.

Balance of trade in goods (visibles)
Balance of trade in services (invisibles) e.g. tourism, insurance
Net income flows (wages and investment income)
Net current transfers (e.g. govt aid)

Financial account

This is a record of all transactions for financial investment. It includes:

Net investment from abroad (e.g. A UK firm buying a factory in Japan would be a debit item)

Net financial flows - These are mainly short term monetary flows such as “hot money flows” to take advantage of exchange rate changes

Reserves
(note the Financial Account used to be called the Capital Account)

Capital Account

This refers to the transfer of funds associated with buying fixed assets such as land

Balancing Item

In practice when the statistics are compiled there are likely to be errors therefore the balancing item allows for these statistical discrepancies

Balance of Payments Equilibrium

In a floating exchange rate the supply of currency will always equal the demand for currency, and the balance of payments is 0.
Therefore if there is a deficit on the current account there will be a surplus on the financial / capital account.
If there was an increase in interest rates this would cause hot money flows to enter into the UK, therefore there would be a surplus on the financial account

The appreciation in the exchange rate would make exports less competitive and imports more competitive therefore with less X and more M there would be a deficit on the current account.

Cyclical Nature of Current Account

In the UK, a current account deficit often increases after a period of economic growth. Higher economic growth leads to higher consumer spending and therefore more spending on imports.

In an economic downturn, spending on imports usually declines leading to a smaller current account deficit.