The Current Account records the flow of goods, services, income, and current transfers. Think of it as a shopping list that shows what a country buys and sells each year. A surplus means the country sells more than it buys; a deficit means it buys more than it sells.
Key Items:
The Financial Account tracks the purchase and sale of financial assets. Imagine it as a bank account ledger where money flows in and out as investments. Positive entries mean foreign investors are buying domestic assets; negative entries mean domestic investors are buying foreign assets.
Typical Flows:
The Capital Account records the transfer of ownership of non-financial assets and capital movements. Think of it as a real estate exchange where land or property ownership changes hands. It is usually small compared with the other accounts.
Examples:
| Account | Main Components | Typical Flow Direction |
|---|---|---|
| Current Account | Goods, Services, Income, Transfers | Exports > Imports (Surplus) or Imports > Exports (Deficit) |
| Financial Account | Direct, Portfolio, Other Investment | Foreign Investment in Domestic Assets (Positive) or Domestic Investment Abroad (Negative) |
| Capital Account | Transfer of ownership of non‑financial assets | Usually small; can be positive or negative depending on asset transfers |
Remember: The balance of payments must balance overall, so the sum of the current, financial, and capital accounts equals zero (ignoring errors and omissions).
Use the “shopping list” analogy: If the country spends more than it earns (current account deficit), it needs to attract foreign investment (financial account surplus) or borrow (capital account).
Key Formula: Current + Financial + Capital = 0
Exam Question Example: “Explain how a persistent current account deficit can be corrected through policies affecting the financial account.” Use the analogy of a “bank account ledger” to illustrate capital inflows.