Short-term transactions include:
● trade credit – as goods are often not paid for as they are received, the physical export
and import of goods is not matched with an inflow or outflow of money. In order that
the balance of payments balances, these amounts would be included here as trade credit;
● foreign currency borrowing and lending abroad by UK banks;
● exchange reserves held by other countries and other organisations in sterling;
● other external banking and money market liabilities in sterling.
These capital transactions are recorded in the UK balance of payments as changes
from the previous year; they are not a record of all the transactions that have taken place
over time. If money is flowing into the UK for investment purposes there is an increase
in the UK’s liabilities and these are shown as positive amounts on the balance of payments.
If money is flowing out of the UK there is an increase in the UK’s assets and these
are shown as negative amounts in the balance of payments.
Up until 1986, capital flows to/from the public sector and capital flows to/from the
private sector were shown in two separate accounts. In 1986, the format of the balance of
payments was then changed to show all capital transactions in one account under the
heading of ‘UK transactions in external assets and liabilities’. In 1998, the format of the
balance of payments was changed once more to bring it in line with the standards published
in the fifth edition of the IMF Balance of Payments Manual. The UK balance of
payments now comprises three sections:
1 the current account as before;
2 the capital account which records capital transfers and transfers of non-financial
assets into and out of the UK; as Table 10.4 shows, the balance on this account was
+£1,030 million in 2002;
3 the financial account which gives the balance of trade in financial assets. This section
of the balance of payments is itself subdivided between direct investment, portfolio
investment, other investments and reserve assets. The balance on the financial
account for 2002 was +£5,629 million.
Speculative flows of currencies would appear in the financial account of the balance
of payments. Portfolio investment is the purchasing of shares in companies, while direct
investment is the setting up of subsidiaries. The main difference between these two elements
of the financial account is the nature of the implied relationship. The purchase of
shares implies a relatively passive relationship, while foreign direct investment implies a
more active, long-term role. More will be said about foreign direct investment later in
this chapter. Reserve assets show the change in official reserves – an increase in official
reserves is shown as a negative amount and a decrease is shown as a positive amount.
The balance of payments overall should balance, as negative flows will be balanced by
positive flows. As this is often hard to understand, two examples will be given.
Example 1
If a UK resident buys foreign goods there will be a negative entry in the current account
equal to the value of those goods. That individual has to pay for those goods in foreign
currency and could do this by using money from a foreign currency bank account if he
has one, or by borrowing the foreign currency from a bank in that country. Either way
there is an increase in the amount of liabilities and the same amount would be shown as
a positive amount in the capital account