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The Balance of Payments

The balance of payments summarises the economic are defined broadly to include people who live in
transactions of an economy with the rest of the Australia, businesses that operate in Australia, the
world. These transactions include exports and Australian government and other organisations
imports of goods, services and financial assets, that operate here.
along with transfer payments (like foreign aid).
The balance of payments divides transactions into
The balance of payments is an important economic
two broad accounts:
indicator for ‘open’ economies like Australia that
• the current account
engage in international trade because it summarises
how resources flow between Australia and our • the combined capital and financial account
trading partners. In essence, the current account captures the net
This Explainer looks at the structure of Australia’s flow of money that results from Australia engaging
balance of payments. in international trade, while the combined capital
and financial accounts capture Australia’s net
change in ownership of assets and liabilities. These
broad accounts are often referred to as the ‘two
sides’ of the balance of payments.
The balance of payments are put together
according to international standards (set out by
the International Monetary Fund (IMF) and the
United Nations) that make it easier to compare
Australia’s balance of payments with that in
Imports other countries.
Exports
The Current Account
Financial The current account records the value of the flow
assets
of goods, services and income between Australian
residents and the rest of the world. There are
three components to the current account – the
‘trade balance’, ‘primary income balance’ and
‘secondary income balance’. In economic analysis
The Structure of the Balance or commentary, most attention is usually given to
of Payments the trade balance, which records the difference
between the value of our exports and imports
Australia’s balance of payments captures the of goods and services. This is because the trade
transactions between Australian ‘residents’ and balance forms part of gross domestic product
the rest of the world, in a given period. ‘Residents’ (see Explainer: Economic Growth).

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The term ‘current’ is used in describing the current assets’; this type of asset includes intangible assets
account because the goods, services and income (e.g. brand names) as well as rights to use land or
being traded in will be consumed or received in water (e.g. for mining or fishing).
the current period (specifically, within the quarter).
The much larger financial account component
records transactions between parties that involve
Current Account a change of ownership of Australia’s assets or
Trade The value of goods and services liabilities. It is structured according to the different
balance that Australian residents export less classes of investment that owners of these assets or
those that they import. liabilities can undertake.
Primary The income that Australian residents
income earn from, less that they pay to, Capital Account
balance the rest of the world from working
Capital Transactions where one party
(e.g. wages) and from financial
transfers has transferred ownership of
investments (e.g. dividends)
something to another party
Secondary Consists of two parts: without receiving anything
income • The income that Australian specific in return. For example:
balance residents earn from, less that • forgiveness of debt (so that
they pay to, the rest of the world the borrower no longer has to
from the government (e.g. tax pay back what they borrowed)
payments and refunds).
• conditional grants for capital
• Current transfers: transactions projects (e.g. foreign aid to
between Australian residents build roads, dams and schools)
and the rest of the world where • transfer of assets between
one party provides something to residents and non-residents.
be consumed by another party Acquisition/ • Transactions that involve
without receiving anything in disposal of intangible assets (e.g. brand
return (e.g. emergency food aid). non-produced, names, copyrights and
non-financial trademarks) and rights to use
The Capital and Financial Account assets land or water (e.g. for mining
or fishing).
The combined capital and financial account records
the capital and financial transactions between
Australia and the rest of the world. Financial Account
The capital account component records two Direct Financial transactions related to
main types of transactions involving capital. investment long-term capital investment
The first is ‘capital transfers’, where one party has in a business (e.g. purchase
transferred ownership of something to another of machinery, buildings and
party without receiving anything in return; capital factories), where the investor has
transfers include conditional grants for specific significant – 10 per cent or more –
capital projects (e.g. a foreign aid project to build voting power in the business (i.e.
roads) and forgiveness of debt. The second type of through ownership of ordinary
transaction involves ‘non-financial, non-produced shares or voting stock).

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Financial Account Accounting Framework
Portfolio The purchase of equity or debt
investment (shares or bonds) in a business. Double Entry
In contrast to direct investment, Any transaction has two sides. In an economic
portfolio investment occurs transaction, something of economic value is
when the investor does not have provided and something of equal value is received.
an influence in the operation of This notion is reflected in the ‘double entry’
the business. accounting framework used in the balance of
Financial The purchase or sale of financial payments. In this framework, for every transaction
derivative derivatives (i.e. financial contracts between an Australian resident and the rest of the
between two parties where the world, the balance of payments will record two
value is derived from another entries. When economic value is provided a credit
financial instrument, such as a entry is made, and when an economic value is
bond or share, or a market index). received a debit entry is made. The credit and the
These transactions involve the debit will be for the same amount, but the credit
exchange of risk between parties, will be recorded as a positive entry and the debit
rather than funds. will be a negative entry. For example, when a
Reserve The purchases or sale of reserve shipment of wheat is exported from Australia to an
assets assets held by the Reserve overseas buyer, a credit entry will be made in the
Bank. These reserves are assets balance of payments reflecting the value of the
controlled by the Reserve Bank shipment that has been provided to the overseas
to meet policy objectives such buyer. On the other side of the transaction, the
as intervention in the foreign Australian seller receives a payment for the wheat
exchange market and to assist the shipment and this payment is recorded as the
Australian government in meeting offsetting debit entry. Since every transaction
its commitments to the IMF. in the balance of payments has two offsetting
Other Transactions that do not fit into entries, the total balance of payments should
investment one of the other categories. be zero.
One example is ‘trade credit’ where
an importer purchases goods from Net Errors and Omissions
overseas and does not pay for the While the total balance of payments should
goods until they are received. be zero, this does not always occur in practice.
Another example is ‘currency This can be due to measurement errors, because
and deposits’, where money it is difficult to accurately record every single
is deposited in or withdrawn transaction between Australian residents and the
from banks across borders, rest of the world. And sometimes transactions are
or banknotes and coins are not measured at all – they are ‘omitted’. Because
transferred between countries. of this there is an additional item included in the
balance of payments, known as ‘net errors and
omissions’, to ensure that it always balances.

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 Box: Some Examples of Credits and Debits
To help illustrate the distinction between different economic transactions and how they are
recorded in the balance of payments, consider the following examples.
1. An Australian mining company exports $100 million of iron ore to a private Chinese steel
maker. The Chinese steel maker will only provide payment for the shipment once it arrives in
China from Australia (which is known as a trade credit because payment is only made after the
goods are received).
The $100m shipment of iron ore from Australia is an export and is recorded as a ‘goods credit’ under
the trade balance. The trade credit payment from the Chinese steel maker is recorded in the financial
accounts as a debit under ‘other investment – trade credit’.
2. Australian residents, including friends Michelle and Megan, go on overseas holidays to Bali
during winter and spend a total of $5 million. The Australian residents pay for their holiday by
using money deposited in their Australian bank accounts.
The $5 million Australian residents spent on overseas travel is an import and is recorded as a
‘service debit’ in the trade balance (specifically ‘import – tourism’). The payments made to overseas
households and businesses (for the accommodation, food, sightseeing, etc.) by the Australian
residents from their domestic bank accounts are recorded in the financial accounts as a credit under
‘other investment – currency and deposits’.
3. Taylor, an Australian resident, buys $20 million of shares in a company listed on the New York
Stock Exchange, equivalent to less than 10 per cent of the voting rights in that company.
The shares are paid for using money from Taylor’s bank account in Australia.
The $20 million of shares purchased by Taylor is recorded in the financial account as a debit under
‘portfolio investment’, because the purchase does not result in a significant degree of influence over
the firm. The payment for the shares is made from Taylor’s Australian bank account and recorded in
the financial accounts as a credit under ‘other investment – currency and deposits’.
Continued over page.

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 Continued from previous page.

Sample of Balance of Payments*

Credit Debit Net
(Credit plus Debit)
Current account $100m -$5m $95m
Trade balance $100m -$5m $95m
- Goods $100m(1) $100m
- Services -$5m(2) -$5m
Primary income balance
Secondary income balance
Capital account
Capital transfers
Acquisition/disposal of non-produced
non-financial assets
Financial account $25m -$120m -$95m
Direct investment
Portfolio investment -$20m(3) -$20m
Other investment $5m(2)
-$100m(1) -$75m
$20m(3)
Reserve assets
Net errors and omissions
Balance of payments $125m -$125m $0m
* Example number indicated in brackets.

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The Relationship Between We can summarise the relationship between
the accounts with an example of Australian
the Accounts economic developments. Australia has tended to
The current account is always offset by the capital borrow from overseas, reflecting investment in
and financial account so that the sum of these the Australian economy. The capital flowing into
accounts – the balance of payments – is zero. Australia is recorded as a credit in the balance of
The logic underlying this, and represented in payments and has been associated with a capital
the double-entry accounting framework, is that and financial account surplus. This surplus is
the value of whatever is traded (recorded in the matched by a current account deficit (recorded as
current account) is offset by a movement of some a debit). Part of the reason for Australia’s current
form of asset to pay for it (recorded in the capital account deficit is the interest Australia pays to the
and financial account). Consequently, when the rest of the world on its international borrowing.
balance of one account is in surplus (i.e. has a
positive value, representing a credit), the balance
of the other account must be in deficit (i.e. has a
negative value, representing a debit).

Stylised Balance of Payments for Australia

Credit

Capital and Financial

Account Balance

+50bn
(surplus)

= zero
Current
Account Balance

–50bn
(deficit)

Debit

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