The Reasons for Measuring the Balance of Payments

To measure performance

A country’s Balance of Payment may be likened to the annual income and expenditure of a household, although the comparison must not be carried too far. The household receives income by supplying the services of factors of production and spends that income on the purchase of goods and services it requires. If the household spends all its income, no more and no less, it is in the same position as a country whose Balance of Payments just balances, if it spends more than its income either by borrow- ing or drawing on past savings, the household has a balance of payments deficit for the year, if its expenditure falls short of income, it may regard itself as having a balance of payments surplus.

This illustrates one reason for assessing the Balance of Payments. It shows whether or not the country as a whole is paying its way in the world. The Government needs an assessment of the Balance of payment in order to check that the community is living within its means.

To protect the foreign currency reserves

Goods imported from abroad have to be paid for in currency acceptable to the supplier. Individual
importers do not keep stocks of foreign currencies needed to buy goods overseas but they can acquire
them from the Central Bank of Nigeria (CBN). A second important reason for keeping track of the
Balance of Payments is that a deficit leads to the reduction in these reserves and prolonged deficits
force the Government (CBN) to take restrictive actions in order to preserve the currency for essential purposes.

To inform governmental authorities of the international position of the country.

To aid governmental authorities in reaching decisions on monetary and fiscal policy on the one hand and trade and payment questions on the other.

They are used to measure the resource flows between one country and another.

Information on payments and receipts in foreign exchange constituting a foreign exchange budget, helps to assure monetary authorities that the country could go on buying foreign goods and meeting payments in foreign currency when they become due.

To measure the influence of foreign transactions on national income. 

Students Assessment Exercise

• Define the terms “Balance of Payments” and Balance of Trade” 
• There is no reason to expect the balance of Trade to balance. But the balance of payment must always balance. Discuss. 
• What are invisible exports and invisible imports? Give examples of both and discuss their relatives importance for Nigeria. 
•  Can a deterioration in a country’s international terms of Trade cause an improvement in that country’s balance of Trade? 

 The Components/Structure of the Balance of Payments

Lipsey (1983), said that a more analytically convenient way to present a nation’s balance of payment is to divide it into three components, viz Current Account, Capital Account, and Official Financing.

The Capital Account

These records transactions related to movement of long and short-time capital i. e. it shows the volume of private foreign investment and public grants and loans from individual nations and multilateral donor agencies such as UNDP and the World Bank. It includes direct investment, portfolio investment, long-term capital and short-term capital. The capital account will be a deficit if payment exceed receipts but a surplus if receipts exceed payments.

The capital account section records all capital movements. They do not consist of goods and services but debts and paper claims such as long term and short term loans that government and private citizens make or receive from foreign government and private citizens.

The capital account is very crucial because it is used to finance any deficit on the balance of trade (i. e. current account deficit) and also used to finance a net flow of goods to the recipients country. This explains why the balance of payments must always balance.

The Current Accounts

The account of import and export goods and services is known as the current account. This is the basic component of the balance of payments. It equally has the largest entries. The current account is further divided into two sections: merchandise trade items and service transaction items.

The merchandise items refer to the import and export of goods (merchandise). This is also known as visible items or visible trade items. The service items are known as invisible items.

The difference between the debit and credit entries in the current account is known as balance of Trade. The balance of Trade is said to b e “favourable” or surplus if exports (sources of foreign exchange) exceeds imports (use of foreign exchange). It is also said to be “unfavourable” or “deficit” if the imports exceed exports.


In most cases, when the balance of payment is said to be in deficit or in surplus, reference is being made to the current account or one account heading not to the total of all balance of payment entries. This is because, in totals the balance on the Capital Account normally offsets the balance on current account. An excess of imports over exports (a debit balance on current account), creates an international debt obligation which is an equivalent credit balance in the capital account.