Current account of the balance of payments

The Balance of Payments (BoP) is a comprehensive record of all economic transactions between one country and the rest of the world over a specific period. It's split into three main parts: the Current Account, the Capital Account, and the Financial Account. The Current Account is the most cited part and acts like a country's annual income statement. It tracks the flow of money from trade in goods and services, plus flows of income and transfers. Money flowing into the country is recorded as a credit (+), such as money received for exports. Money flowing out of the country is recorded as a debit (-), such as money spent on imports.

The current account is made up of four distinct sections that together provide a detailed picture of a country's international transactions. 1. Trade in Goods (Visible Trade): This records the export and import of physical products, like cars, food, and machinery. The difference between the value of visible exports and visible imports is called the 'Balance of Trade'. 2. Trade in Services (Invisible Trade): This records the export and import of non-physical services, such as tourism, banking, insurance, and transportation. The difference is the 'Balance on Services'. 3. Primary Income: This component tracks income earned by factors of production owned abroad. It includes wages paid to residents working overseas (credit), profits sent back from foreign subsidiaries (credit), and interest and dividends earned on foreign assets (credit). It also includes the corresponding payments made to foreigners (debits). 4. Secondary Income (Current Transfers): This records one-way payments where nothing is received in return. Examples include foreign aid sent to other countries (debit), remittances sent home by migrant workers (credit), and contributions to international organisations like the UN (debit).

A current account deficit occurs when a country's total debits (spending on imports and income/transfer outflows) exceed its total credits (earnings from exports and income/transfer inflows). There are several potential causes: 1. Strong Domestic Growth: When an economy is growing quickly, consumers have higher incomes and tend to spend more, including on imported goods and services. This increases import debits. 2. High Relative Inflation: If a country's inflation rate is higher than its trading partners, its exports become relatively more expensive and imports become relatively cheaper. This reduces export demand and increases import demand. 3. Overvalued Exchange Rate: A strong (overvalued) currency makes exports more expensive for foreigners and imports cheaper for domestic consumers, worsening the trade balance. 4. Lack of Competitiveness: This is a long-run, structural problem. If a country's industries are inefficient, have low productivity, or produce low-quality goods, they will struggle to sell exports, while consumers may prefer higher-quality imports. 5. Recession in Trading Partners: If a country's main export markets go into recession, demand for its exports will fall, reducing credit inflows.

While a small, temporary deficit is not usually a major concern, a large and persistent current account deficit can have significant negative consequences for an economy. Firstly, it puts downward pressure on the exchange rate. To pay for excess imports, the country must supply more of its currency on foreign exchange markets, which can cause its value to fall (depreciate). Secondly, a current account deficit must be paid for. This is done by running a surplus on the financial account, which means either attracting foreign investment (e.g., selling domestic assets like property or companies to foreigners) or by borrowing from abroad. This can lead to a build-up of external debt, which requires future interest payments (a debit on the primary income account), worsening the deficit in the long run. Thirdly, a persistent deficit can be a symptom of a structurally uncompetitive economy, which may deter long-term foreign direct investment (FDI) and signal economic weakness. Finally, if the deficit is caused by a decline in export industries, it can lead to structural unemployment and a fall in aggregate demand.

A current account surplus occurs when a country's credits (from exports and income inflows) are greater than its debits (from imports and income outflows). This means the country is a net lender to the rest of the world. Key causes include: 1. High Export Competitiveness: This can be due to high productivity, low relative inflation, innovative products, or an undervalued exchange rate, all of which make the country's goods and services very attractive globally. 2. Weak Domestic Demand: If consumers and firms in the country are saving a lot and spending little (perhaps during a recession), demand for imports will be low. 3. Strong Growth in Trading Partners: When other countries are growing strongly, their demand for the surplus country's exports will be high. Consequences of a surplus can include: an appreciation of the exchange rate as demand for the currency rises; potential for demand-pull inflation if the economy is operating near full capacity; and the ability to build up foreign assets and become a net creditor nation. However, a large surplus may also indicate an unbalanced economy with overly low domestic consumption and investment.

Governments can use several types of policies to try and reduce a current account deficit. These fall into three main categories: 1. Expenditure-Switching Policies: These policies aim to make consumers and firms switch their spending from imported goods to domestically produced goods. The main tools are protectionist measures like tariffs (taxes on imports) and quotas (limits on the quantity of imports), which make imports more expensive or scarce. Another key policy is causing a devaluation or depreciation of the exchange rate, which makes exports cheaper and imports more expensive. 2. Expenditure-Reducing Policies: These policies aim to reduce overall spending (aggregate demand) in the economy. The logic is that if people spend less in total, they will also spend less on imports. The main tools are contractionary fiscal policy (increasing taxes, cutting government spending) and contractionary monetary policy (increasing interest rates to discourage borrowing and spending). 3. Supply-Side Policies: These are long-term policies designed to improve the international competitiveness of the domestic economy. By making domestic firms more efficient and innovative, they can increase their exports. Examples include investing in education and training to improve labour productivity, deregulation to reduce business costs, and improving infrastructure like ports and broadband.