Current account of the balance of payments

CAIE Alevel Economics (AS)

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components of the current account of the balance of payments

A country's balance of payments (BoP) is a systematic record of all economic transactions between residents of a given country and the rest of the world over a certain period of time, typically one year.

The BoP records all transactions in goods, services, and assets, and is divided into three main components:

Current account: records transactions in goods, services, income, and current transfers.
Financial account: records transactions in financial assets and liabilities, such as foreign direct investment, portfolio investment, and banking flows.
- A surplus on the financial account means that a country is receiving more investment from abroad than it is investing abroad.
Capital account: records transactions in non-produced, non-financial assets, such as patents, copyrights, and trademarks. It also records capital transfers, such as debt forgiveness or migration-related remittances.

Components of the current account

Trade in goods: records a country's transactions in physical goods with the rest of the world, including exports and imports of goods.
- Exports of goods generate revenue for the domestic economy, while imports of goods represent a cost to the domestic economy.
Trade in services: records a country's transactions in services, such as travel, transportation, insurance, and financial services, with the rest of the world.
- Exports of services generate revenue for the domestic economy, while imports of services represent a cost to the domestic economy.
Primary income: records income received by domestic residents from abroad and income paid to foreign residents by the domestic economy.
- Examples of primary income include wages and salaries earned by workers in a foreign country, and profits earned by a domestic company with foreign operations.
Secondary income: records transfers of money, goods, or services between residents of a country and non-residents that do not involve a quid pro quo.
- Examples of secondary income include foreign aid, remittances, and gifts.

The balance of the current account represents the difference between a country's receipts and payments for goods, services, income, and transfers with the rest of the world.

If a country is receiving more in revenue than it is paying out for goods, services, income, and transfers, it has a current account surplus.
- A current account surplus indicates that a country is a net lender to the rest of the world, meaning that it is exporting more than it is importing, and/or receiving more income and transfers from abroad than it is paying out.
If it is paying out more than it is receiving, it has a current account deficit.
- A current account deficit indicates that a country is a net borrower from the rest of the world, meaning that it is importing more than it is exporting, and/or paying out more income and transfers to abroad than it is receiving.

calculation of balances in current account

Transaction	Amount (millions of USD)
Exports of goods	1000
Imports of goods	1500
Balance of trade in goods	-500
Exports of services	800
Imports of services	600
Balance of trade in services	200
Balance of trade in goods and services	-300
Primary income receipts	400
Primary income payments	300
Secondary income receipts	200
Secondary income payments	100
Current account balance	-100

The balance of trade in goods is calculated as exports of goods minus imports of goods, which is a deficit of 500 million USD.
The balance of trade in services is calculated as exports of services minus imports of services, which is a surplus of 200 million USD.
The balance of trade in goods and services is calculated as the sum of the balance of trade in goods and the balance of trade in services, which is a deficit of 300 million USD.
The current account balance is calculated as the sum of the balance of trade in goods and services, primary income receipts, and secondary income receipts, minus the sum of the primary income payments and secondary income payments, which is a deficit of 100 million USD.

causes of imbalances in the current account of the balance of payments

Causes of current account deficit

Trade imbalances: A country may have a current account deficit if it imports more goods and services than it exports, as this would lead to a negative balance of trade.
Exchange rates: If a country's currency is overvalued relative to other currencies, its exports become more expensive and less competitive, while imports become cheaper and more attractive, leading to a current account deficit.
Income levels: A country with high levels of income may tend to have higher imports of goods and services, leading to a current account deficit.
Government policies: Government policies such as fiscal and monetary policies can impact a country's current account balance. For example, expansionary fiscal policies can increase imports and cause a current account deficit.

Causes of current account surplus

Trade imbalances: A country may have a current account surplus if it exports more goods and services than it imports, leading to a positive balance of trade.
Exchange rates: If a country's currency is undervalued relative to other currencies, its exports become cheaper and more competitive, while imports become more expensive and less attractive, leading to a current account surplus.
High savings rates: A country with high levels of savings may be able to finance investment and consumption domestically, resulting in a higher level of exports and a current account surplus.
Competitive industries: If a country's industries are highly competitive, it may be able to export more goods and services, leading to a current account surplus.

consequences of imbalances in the current account of the balance of payments

Consequences of a current account deficit for the domestic economy:

Reduced economic growth: A current account deficit can result in reduced economic growth due to the loss of domestic output and employment as a result of increased imports.
Weakened currency: A current account deficit can lead to a weakened domestic currency, as the excess demand for foreign currency to finance the deficit can lead to depreciation of the domestic currency. This can make imports more expensive and exports more competitive, but it can also lead to higher inflation.
Increased debt: A current account deficit means that the country is borrowing from other countries to finance its imports. This can lead to a buildup of foreign debt, which can be unsustainable in the long run.

Consequences of a current account surplus for the domestic economy:

Increased economic growth: A current account surplus can result in increased economic growth due to increased domestic output and employment as a result of increased exports.
Stronger currency: A current account surplus can lead to a stronger domestic currency as there is excess demand for the domestic currency to finance the surplus. This can make imports cheaper and exports less competitive.
Trade tensions: A current account surplus can lead to trade tensions with other countries, which may accuse the surplus country of engaging in unfair trade practices, such as currency manipulation or dumping.

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