The balance of payments is the record of all transactions between a country and the rest of the world. Defined as simply as possible, the balance of payments is broken down into the current account and the capital account.
The current account includes payments for exports and imports of goods and services, as well as money sent home by citizens working abroad and income from foreign investments. The capital account covers the difference between the amount that the country’s residents are investing abroad and the amount that foreigners are investing in it, plus some smaller items such as capital transfers and grants to other countries and changes in foreign currency reserves held by the central bank.
The balance of payments is an accounting identity in which every debit must be matched by a credit – so in theory the current account and capital account sum to zero. In practice, measurement errors mean the numbers don’t match up, so the definition includes a balancing item to make up the difference.
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The International Monetary Fund’s official definition refers to the change in ownership of financial assets as the financial account, and uses the term capital account mostly to refer only to some capital transfers, grants and the change in ownership of certain fixed assets.
A balance of payments crisis occurs when a country can no longer pay for imports or service its debts. This is usually caused by a sudden stop in inflows (or large outflows) in the capital account. Both developed and emerging market nations regularly run current-account deficits (the UK has run a deficit for many decades now). But emerging markets – partly due to their more fragile institutions, and partly due to the fact that more “hot” (speculative) money tends to flow their way in the good times – tend to be far more vulnerable to rapid losses of confidence.
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