International Trade and Globalisation – The Current Account of the Balance of Payments
1. What is the Current Account?
The current account records all transactions that involve the flow of goods, services, primary income and secondary income between residents and non‑residents during a given period. It excludes capital‑account and financial‑account flows (e.g., FDI, portfolio investment).
2. Structure of the Current Account (Syllabus 6.4.1)
- Trade in Goods (Merchandise) – exports and imports of physical products such as cars, food, machinery.
- Trade in Services – tourism, transport, insurance, consulting, education, software, etc.
- Primary Income (Factor Income) – earnings on foreign‑owned assets (interest, dividends, rent) and compensation of employees working abroad.
- Secondary Income (Unilateral Transfers) – gifts, remittances, foreign aid, pension payments received from abroad.
3. Calculating the Current‑Account Balance (Syllabus 6.4.2)
Standard formula:
CA = (X – M) + Primary Income + Secondary Income
where X = exports of goods + services and M = imports of goods + services.
Worked example
| Item | £ millions |
|---|
| Exports of goods & services (X) | 200 |
| Imports of goods & services (M) | 150 |
| Primary income received – paid | +30 – 20 = +10 |
| Secondary income received – paid | +10 – 5 = +5 |
| Current‑account balance | +55 million (surplus) |
4. Causes of Current‑Account Surpluses and Deficits (Syllabus 6.4.2)
Typical causes of a surplus
- Improved terms of trade – export prices rise relative to import prices.
- Depreciation of the domestic currency – makes exports cheaper and imports more expensive.
- High domestic saving relative to domestic investment – excess saving is used to purchase foreign assets.
- Large remittance inflows or other unilateral transfers.
- Strong export‑oriented sectors (manufacturing, tourism, services).
Typical causes of a deficit
- Appreciation of the domestic currency – reduces export competitiveness.
- High domestic demand for imported goods (consumer preferences, low domestic production capacity).
- Large outflows of primary income, e.g. interest and dividend payments on foreign‑direct investment (FDI) or external debt.
- Fiscal expansion (higher government spending) that stimulates import‑driven consumption.
- Insufficient domestic saving to fund investment.
5. Impact on Gross Domestic Product (Syllabus 6.4.3a)
GDP identity:
GDP = C + I + G + (X – M)
- Current‑account surplus (X > M) → net‑export component is positive → adds to GDP.
- Current‑account deficit (M > X) → net‑export component is negative → reduces GDP.
6. Impact on Employment (Syllabus 6.4.3b)
- Export‑oriented sectors – growth in exports raises labour demand in manufacturing, agriculture, tourism and export‑related services (e.g., finance, IT).
- Import‑competing sectors – a rise in imports can shrink domestic output, leading to job losses unless resources shift to more competitive industries.
- Service exports – tend to create higher‑skill, higher‑pay jobs (consultancy, software development, education).
- Remittances & unilateral transfers – increase household income, which can raise labour‑force participation, especially among low‑income families.
7. Impact on Inflation (Syllabus 6.4.3c)
Two main channels link the current account to the price level:
- Import‑price effect – cheaper imports exert downward pressure on domestic prices; expensive imports push them up.
- Exchange‑rate pass‑through – a depreciation of the domestic currency raises the local‑currency price of imports, feeding into consumer‑price inflation.
Consequently, a persistent current‑account deficit often coincides with a weaker currency and higher imported‑inflation, whereas a surplus can help contain inflation if it leads to currency appreciation.
8. Impact on the Foreign‑Exchange Rate (Syllabus 6.4.3d)
The current account influences the supply and demand for the domestic currency in the foreign‑exchange market.
ΔE / E ≈ ΔCA / CA
where E is the exchange rate (domestic currency per unit of foreign currency) and CA is the current‑account balance.
- Surplus → higher demand for the domestic currency → appreciation.
- Deficit → higher demand for foreign currency → depreciation.
9. Wider Consequences of Current‑Account Imbalances (Syllabus 6.4.3e)
- Balance‑of‑payments stability – large, persistent deficits may deplete foreign‑exchange reserves and raise the risk of a balance‑of‑payments crisis.
- External‑debt sustainability – deficits financed by borrowing increase external debt and future interest‑payment obligations.
- Policy credibility – chronic imbalances can undermine confidence in the government’s macro‑economic management, affecting investment and borrowing costs.
- Terms of trade – sustained surpluses can improve a country’s terms of trade; deficits can have the opposite effect.
10. Policy Measures to Influence the Current Account (Syllabus 6.4.4)
Cambridge IGCSE expects students to name the main tools and explain how they affect the current account.
- Fiscal policy
- Increase indirect taxes on imported goods (e.g., higher VAT) → reduces import demand.
- Provide export subsidies or tax relief for export‑oriented firms → raises export supply.
- Cut government spending that fuels import‑driven consumption.
- Monetary policy
- Raise interest rates → attract foreign capital, support currency appreciation, make imports cheaper relative to exports.
- Lower interest rates → stimulate domestic demand, but may increase import demand and widen the deficit.
- Trade policy
- Tariffs or import quotas – directly limit import volumes.
- Export promotion schemes – marketing assistance, quality certification, export credit.
- Negotiating trade agreements that improve market access for domestic exporters.
- Exchange‑rate policy
- Direct intervention in the foreign‑exchange market (buying domestic currency to support it or selling to weaken it).
- Adopting a managed float or a fixed exchange‑rate regime to stabilise the currency.
11. Summary Table – Effects of Current‑Account Movements (Syllabus 6.4.3)
| Current‑Account Position |
Effect on GDP |
Effect on Employment |
Effect on Inflation |
Effect on Exchange Rate |
Other Macro‑economic Consequences |
| Surplus (X > M) |
Increases GDP via a positive net‑export component. |
Job creation in export‑oriented sectors; possible losses in import‑competing sectors. |
Import‑price pressure tends to be downward; any currency appreciation may offset this. |
Currency tends to appreciate. |
Improved balance‑of‑payments stability; lower pressure on reserves; may boost policy credibility. |
| Deficit (M > X) |
Reduces GDP via a negative net‑export component. |
Job losses in import‑competing industries; gains in sectors that use imported inputs. |
Depreciation‑induced rise in import prices can fuel inflation. |
Currency tends to depreciate. |
Higher risk of reserve depletion, larger external‑debt burden, possible balance‑of‑payments crisis if prolonged. |
12. Suggested Diagram
Flow diagram of current‑account transactions – show arrows from (i) Exports of goods & services, (ii) Imports of goods & services, (iii) Primary income, and (iv) Secondary income converging on the “Current‑Account Balance”. From this box draw arrows to four impact boxes: (a) GDP (via the (X‑M) component), (b) Employment (sectoral labour demand), (c) Inflation (import‑price & exchange‑rate pass‑through), (d) Foreign‑exchange market (appreciation or depreciation). Use colour‑coding (e.g., green for surplus‑induced positive effects, red for deficit‑induced negative effects) to aid visualisation.