What is a balance of payments?

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The Balance of Payments refers to the sum of all transactions that are made between a nation and the rest of the world. These transactions can be recorded as entries in the current account or the capital account.

The current account includes items that can be classified under exports and imports and the funds that are spent by citizens of the nation in other countries and by foreign citizens in that nation.

Capital account includes foreign direct investment made by foreign entities into a nation and direct investment made by entities of that nation into other nations.

When the current and capital accounts are added together, the result is usually not equal to zero. The difference, which may be positive or negative has to be balanced. If there is a net outflow of funds it is displayed as a decrease in the foreign reserves and is usually compensated by borrowing funds from abroad. A net inflow of funds increases the foreign exchange reserves and the nation is in a position to lend money to other nations.

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