Reasons for current account deficits and surpluses

International Trade and Globalisation – Current Account of the Balance of Payments

1. What is the Current Account?

The current account (CA) records a country’s transactions with the rest of the world that involve the flow of goods, services, primary income and secondary (current) transfers. It is one of the three main components of the Balance of Payments (BOP):

• Current Account – trade in goods & services, income and transfers.
• Capital Account – capital transfers and the acquisition/disposal of non‑produced, non‑financial assets.
• Financial Account – direct investment, portfolio investment, other investment and reserve assets.

2. Structure of the Current Account (Cambridge Syllabus 6.4)

The CA is divided into four sub‑components. The syllabus uses the term secondary income for current transfers.

• Trade in goods (exports – imports of physical products)
• Trade in services (exports – imports of services such as tourism, insurance, software)
• Primary income (earnings on investments – interest, dividends, profits received from abroad minus similar payments made to foreign investors)
• Secondary income / current transfers (one‑way transfers – remittances, foreign aid, gifts, pensions received minus those sent abroad)

3. Calculating the Current‑Account Balance

Show‑your‑working format (AO2)

1. Calculate net goods: Exports – Imports
2. Calculate net services: Exports – Imports
3. Calculate net primary income: Receipts – Payments
4. Calculate net secondary income: Receipts – Payments
5. Sum the four results – a positive total = surplus, a negative total = deficit.

Illustrative Example 1 (step‑by‑step)

Working:

Net goods          = 150 – 200 = -50
Net services       =  80 –  60 =  +20
Net primary income =  30 –  45 = -15
Net secondary inc. =  10 –   5 =  +5
CA = -50 + 20 - 15 + 5 = -40  → deficit

Practice Exercise 2 (original)

Answer (showing each line):

Net goods          = 420 – 380 = +40
Net services       = 150 – 170 = -20
Net primary income =  60 –  45 = +15
Net secondary inc. =  25 –  35 = -10
CA = 40 – 20 + 15 – 10 = +25  → surplus

Practice Exercise 3 (new – tests sign convention)

Calculate the CA and state whether it is a deficit or a surplus.

Answer:

Net goods          = 300 – 340 = -40
Net services       = 120 – 100 = +20
Net primary income =  45 –  60 = -15
Net secondary inc. =  15 –  10 = +5
CA = -40 + 20 - 15 + 5 = -30  → deficit

4. Causes of a Current‑Account Deficit (aligned with syllabus headings)

1. Demand‑side factors (high import demand)
   • Strong consumer confidence → greater spending on foreign goods.
   • Rapid economic growth → higher demand for imported capital goods and intermediate inputs.
   • Low domestic saving rate → households and firms finance consumption/investment by borrowing abroad.
2. Supply‑side factors (weak export performance)
   • High production costs (wages, energy, raw materials) make domestic goods relatively expensive.
   • Real exchange‑rate appreciation → exports become costly for foreign buyers.
   • Poor product quality, limited innovation or narrow export base.
3. Income factor
   • Large foreign‑direct‑investment (FDI) portfolio abroad → profit, dividend and interest outflows.
   • High interest payments on external debt.
4. Transfers factor
   • Net outflows of remittances (workers sending money home) or foreign aid paid to other countries.
5. Exchange‑rate factor
   • Appreciation of the domestic currency reduces export competitiveness and makes imports cheaper.
6. Structural / policy factor
   • Economy oriented toward consumption rather than export‑led growth.
   • Geographic isolation or poor transport infrastructure raises export costs.
   • Low tariffs on consumer imports combined with little support for export sectors.

Link to macro‑aims: A persistent current‑account deficit can threaten the BOP’s stability and may force a country to draw down foreign‑exchange reserves or incur unsustainable external debt.

5. Causes of a Current‑Account Surplus (mirror of the deficit list)

1. Supply‑side strength (competitive export sector)
   • Low production costs, high productivity or access to unique natural resources (oil, minerals, rare‑earths).
   • Real exchange‑rate depreciation or undervaluation → exports become cheaper for foreign buyers.
   • High‑quality, innovative or niche products that attract strong overseas demand.
2. Demand‑side restraint (weak import demand)
   • Low consumer confidence, high unemployment or tight credit conditions reduce import consumption.
   • Protectionist measures (tariffs, quotas, import licences) that limit the volume of imports.
3. Income factor
   • Large earnings from overseas investments (dividends, interest, profits) that exceed payments made abroad.
   • Repatriation of profits from multinational corporations headquartered at home.
4. Transfers factor
   • Significant remittances received from citizens working abroad.
   • Foreign aid, grants or charitable donations received.
5. Exchange‑rate factor
   • Depreciation of the domestic currency makes imports more expensive and exports cheaper, improving the trade balance.
6. Structural / policy factor
   • Export‑oriented development strategies (e.g., the East Asian “export miracle”).
   • Targeted investment in sectors with high export potential such as electronics, textiles, shipbuilding or services.

6. Policy Measures to Correct a Current‑Account Deficit

These are specific tools that governments or central banks can use. Each aims to reduce import demand, improve export competitiveness, or alter the income/transfer balance.

• Import tariffs or quantitative restrictions (quotas, licences) – raise the price of imported goods, reducing import volume.
• Exchange‑rate appreciation (or intervention to support the currency) – makes imports cheaper but is usually combined with supply‑side reforms to avoid worsening the deficit.
• Fiscal tightening (higher taxes, reduced public spending) – lowers domestic disposable income, curbing demand for imports.
• Monetary tightening (higher interest rates) – strengthens the currency and reduces credit‑driven import spending.
• Supply‑side reforms – invest in productivity, infrastructure and skills to lower production costs and boost export competitiveness.

7. Policy Measures to Reduce an Excessive Current‑Account Surplus

• Export taxes or removal of export subsidies – lower the incentive to export, reducing surplus.
• Exchange‑rate depreciation (or foreign‑exchange intervention to weaken the currency) – makes imports cheaper and exports relatively more expensive, re‑balancing trade.
• Fiscal expansion (lower taxes, increased public spending) – raises domestic demand for imported goods.
• Monetary easing (lower interest rates) – can stimulate domestic consumption and investment, increasing import demand.
• Promotion of import‑substituting industries – reduces reliance on foreign goods without harming export sectors.

8. Summary Table – Key Drivers of Deficits and Surpluses

9. Suggested Diagram

10. Quick Revision Questions

1. Explain how an appreciated domestic currency can lead to a current‑account deficit.
2. Identify two specific policy measures a government could adopt to reduce a persistent current‑account deficit and explain how each works.
3. Why might a country with a large overseas investment portfolio record a current‑account surplus?
4. Using the data in Practice Exercise 2, show the step‑by‑step calculation of the current‑account balance.
5. Distinguish between “primary income” and “secondary (current) transfers” and give one example of each.