Story: Balance of payments
Page 2 – Current, financial and capital accounts
Money transactions are reported in the current account of the balance of payments.
The current account has four components:
- The balance on goods, which records exports and imports of physical, relocatable merchandise. The export of kiwifruit, for example, brings in a credit, while the import of cars creates a debit.
- The balance on services, which records transactions relating to the provision of non-physical items such as transport, travel and insurance.
- The balance on investment income, which records dividends and interest payments that New Zealanders earn on assets held overseas, and also payments to foreign residents on assets held in New Zealand.
- The balance on current transfers, which records transactions relating to the provision of goods, services, cash or other items of value between residents and non-residents that are intended to be used for consumption in the short term and for which there is no payment. A good example is the money that immigrants may send to relatives in their home country.
In the early 2000s money sent from Tongans in New Zealand, Australia and the United States back to their families made up about half the national income of Tonga. Much of the money from New Zealand was sent through Western Union, which had two branches in the Tongan capital, Nuku’alofa.
Each of these balances may be negative (a deficit) or positive (a surplus). Their sum is the current account balance.
New Zealand normally runs a current account deficit. This means that it uses more resources for consumption and investment than it generates at home. New Zealand’s current account deficit (as a proportion of its economy) is amongst the largest in the OECD group of countries.
The shortfall in New Zealand’s current account is financed by borrowing in international capital markets, selling assets or incurring liabilities to foreign residents. Such flows, along with those relating to foreign assets bought by New Zealanders, are recorded in the financial account.
When foreign residents buy more assets in New Zealand than New Zealanders buy abroad (as has been most often the case), more capital flows into the country than out. Then a net surplus is recorded on the financial account.
Three main kinds of flows figure in the financial accounts:
- Direct investment, which is a lasting and significant interest in a business in another country. Officially it is an investment in at least 10% of the voting capital (or equity) of a company or other enterprise. Such investments are stable in the sense that investors are unlikely to pull their money at short notice.
- Portfolio investment, which includes transactions in stocks and bonds where the investment does not allow the investor to have any influence on the operations of the foreign business (that is, less than 10% equity). Such investments are sensitive to changes in investor sentiment.
- Reserve assets, which are financial assets that can be bought and sold only by monetary authorities (central banks, such as New Zealand’s Reserve Bank) and include a country’s official reserves of foreign exchange.
- Other investment, which is a residual category that includes trade credits and private holdings of foreign currency.
The third component of the balance of payments statement is the capital account, which includes capital transfers. As with current transfers, capital transfers also involve the movement of cash or other items of value, but are intended to be for investment rather than consumption. Such transfers include official debt forgiveness and the money migrants bring into the country. The balance (the difference between the money going in and out of the country) on the capital account is small relative to the current and financial accounts.
In theory, a country’s balance of payments must add up to zero, since any deficits (or surpluses) on the current account are funded by inflows (or outflows) recorded in the financial and capital accounts. In practice there is not normally a zero balance because of small errors in the varied sources used to compile the figures. So an amount called a ‘net error’ or ‘residual’ is inserted to ensure that the balance of payments does indeed balance (add up to zero).