Current Account of Balance of Payments (Copy)

6.4.1 Structure of the Current Account

The Balance of Payments (BOP) records all economic transactions between residents of a country and the rest of the world.

The Current Account is the most important section, showing trade and income flows.

Main components:

1. Trade in Goods (visible trade)
   • Exports and imports of physical goods (cars, oil, electronics, machinery).
   • If exports > imports → trade surplus.
   • If imports > exports → trade deficit.
2. Trade in Services (invisible trade)
   • Exports and imports of services (banking, tourism, insurance, education, consultancy).
   • Example: UK runs a large surplus in financial services.
3. Primary Income
   • Income from investments abroad: interest, dividends, profits.
   • Wages sent home by citizens working abroad.
   • Example: Profits earned by a British company in India returning to UK.
4. Secondary Income (Transfers)
   • Transfers of money with no good/service exchanged.
   • Examples: foreign aid, remittances, membership contributions to international organisations.

Current Account Balance Formula (clean text version):

Current Account Balance = (Exports of Goods – Imports of Goods) + (Exports of Services – Imports of Services) + Net Primary Income + Net Secondary Income

6.4.2 Causes of Current Account Deficit and Surplus

Causes of Current Account Deficit

• High imports, weak exports → Consumers prefer foreign goods, poor competitiveness of domestic firms.
• Strong currency (appreciation) → Exports expensive abroad, imports cheaper.
• Economic growth (domestic boom) → Higher incomes increase imports.
• Structural weaknesses → Small manufacturing sector, dependence on imported raw materials.
• Global demand falls → World recession reduces exports.
• High inflation → Domestic goods less competitive internationally.

Causes of Current Account Surplus

• Strong exports → Competitive industries, high foreign demand.
• Weak currency (depreciation) → Exports cheaper, imports expensive.
• High savings, low spending → Countries like Japan, China import less.
• Low inflation → Exports remain competitive.
• Global demand growth → Commodity exporters benefit from rising prices.

6.4.3 Consequences of Current Account Deficit and Surplus

Consequences of a Current Account Deficit

• Currency depreciation → Demand for foreign exchange rises as imports increase.
• Unemployment in export industries → Lower demand reduces jobs.
• Lower GDP growth → Net exports (X – M) is part of GDP, deficit reduces growth.
• Foreign debt increases → Government may borrow to finance deficit.
• Imported inflation → Depreciation makes imports more expensive.

Consequences of a Current Account Surplus

• Currency appreciation → High demand for exports raises exchange rate.
• High growth and jobs → Export sector boosts employment and output.
• Over-dependence on exports → If world demand falls, economy slows.
• International criticism → Surplus countries accused of unfair trade practices.

6.4.4 Policies to Achieve Balance of Payments Stability

Governments use 3 main approaches:

1. Expenditure-Reducing Policies
   • Reduce demand for imports by cutting overall spending.
   • Fiscal policy: raise taxes, cut government spending.
   • Monetary policy: raise interest rates to reduce borrowing.
   • Drawback: may slow growth and raise unemployment.
2. Expenditure-Switching Policies
   • Shift demand from imports to domestic goods.
   • Devaluation (in fixed system) or depreciation (in floating system) → exports cheaper, imports dearer.
   • Protectionism: tariffs, quotas, subsidies for domestic firms.
   • Drawback: risk of retaliation or inflation.
3. Supply-Side Policies
   • Long-term competitiveness improvements.
   • Invest in education, technology, infrastructure.
   • Deregulation to lower business costs.
   • Slow to take effect, but sustainable.
4. Exchange Rate Management
   • In fixed systems: central bank buys/sells currency to maintain target rate.
   • In floating systems: influenced indirectly by interest rates and monetary policy.

Diagram Representations

Current Account Components (Tree Diagram):

Current Account
 ├── Trade in Goods
 ├── Trade in Services
 ├── Primary Income
 └── Secondary Income

Policies for Stability (Mindmap Style):

Balance of Payments Stability
 ├── Expenditure-Reducing (tax ↑, interest ↑)
 ├── Expenditure-Switching (devaluation, tariffs)
 └── Supply-Side (productivity ↑, innovation ↑)