Balance of Payments 

All countries have economic transactions with other countries. These consist of import and export of goods and services, official and private gifts and donations, lending and borrowing abroad and investment abroad in financial and physical assets. The balance of payments (BoP) is a record of all transactions that a country has with the rest of the world during a year.

The BoP is a regular double-entry accounting record with transactions that increase the availability of foreign exchange recorded as credits and those that use up foreign exchange recorded as debits. Thus exports are a credit item while imports are a debit item; lending abroad is a debit item while borrowing from abroad is a credit item. Applying this logic, increases in the foreign exchange reserves of a country are a debit item while decreases are a credit item.

The BoP is divided into a current account consisting of transactions involving imports, exports, remittances and gifts and a capital account which consists of all transactions which affect the country's foreign exchange assets or liabilities. Within each, further subgroups can be made. For instance, the "merchandise account" relates to trade in goods only.

The BoP being a double entry account is by definition always in balance. When we talk of balance of payments deficit or surplus we are focusing on a particular group of transactions such as merchandise trade or the entire current account or all transactions other than changes in official reserves, etc. A variety of definitions of 'imbalance' in external account are therefore possible each suited for a specific purpose. We will discuss these later in the book.