what is the balance of payments?

The Balance of Payments records financial transactions between the UK and the international economy. The accounts are split into two sections with the current account measuring trade in goods and services and the capital account tracking capital flows in and out of the UK. This includes portfolio capital flows (e.g. share transactions and the buying and selling of Government debt) and direct capital flows arising from foreign direct investment  

The current account measures net trade in goods and services.

Balance of Payments

= Trade balance in goods

+ Trade balance in services

+ Net investment income

+ Transfers

= Current Account balance

+ Capital Account Flows

= Basic Balance of Payments

WHY THE BALANCE OF PAYMENTS MUST BALANCE

If a country is running a deficit on the current account then there must be a corresponding surplus in the capital account. This might be achieved by attracting direct foreign investment into the economy, or by the government running down official reserves of foreign currency. 

Another way of "financing" a balance of payments deficit on the current account is to attract short term banking flows into the financial system by offering an attractive rate of interest.