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 records a country’s transactions with the rest of the world that involve the flow of goods, services, income and current transfers. It is a major component of the balance of payments (BOP).

2. Components of the Current Account

• Trade balance (goods and services) – exports minus imports.
• Net primary income – earnings on investments (interest, dividends, profits) received from abroad minus similar payments made to foreign investors.
• Net secondary income (current transfers) – transfers such as remittances, foreign aid, and gifts received minus those sent abroad.

3. Current Account Deficit – Reasons

A current account deficit occurs when a country imports more goods, services and income than it exports. The main reasons are:

1. High domestic demand for imports

   • Strong consumer confidence leads to higher spending on foreign goods.
   • Rapid economic growth raises the import demand for capital goods and intermediate inputs.

2. Low export competitiveness

   • High production costs (wages, energy) make domestic goods relatively expensive.
   • Unfavourable exchange rate – an appreciated domestic currency makes exports pricier abroad.
   • Weak product quality or lack of innovation reduces foreign demand.

3. Large net outflow of primary income

   • High levels of foreign direct investment (FDI) mean that a large share of profits is repatriated.
   • Significant interest payments on external debt.

4. Net current transfers outflow

   • High remittances sent abroad by migrant workers.
   • Large foreign aid contributions.

5. Structural factors

   • Economies that are primarily consumption‑oriented rather than export‑oriented.
   • Geographic isolation increasing transport costs for exports.

4. Current Account Surplus – Reasons

A current account surplus arises when a country exports more than it imports. Typical causes include:

1. Strong export sector

   • Competitive advantage due to low production costs, high productivity, or unique resources (e.g., oil, minerals).
   • Depreciated exchange rate that makes exports cheaper for foreign buyers.
   • High quality or innovative products that command strong foreign demand.

2. Weak domestic demand for imports

   • Low consumer confidence or high unemployment reduces import consumption.
   • Protectionist policies (tariffs, quotas) limit import volumes.

3. Net primary income inflow

   • Significant earnings from overseas investments (e.g., dividends, interest) exceed payments made abroad.
   • Repatriation of profits from multinational corporations headquartered domestically.

4. Net current transfers inflow

   • Large remittances received from citizens working abroad.
   • Foreign aid or grants received.

5. Structural and policy factors

   • Export‑oriented economic strategy (e.g., East Asian “export miracle”).
   • Investment in sectors with high export potential (electronics, textiles, services).

5. Illustrative Example

Consider a simplified economy where the following annual flows are recorded (in billions of dollars):

The overall current account balance is calculated as:

\$\text{Current Account Balance}=(-50)+20+(-15)+5=-40\text{ (billion USD)}\$

Thus the economy runs a current account deficit of $40 bn, indicating that the reasons listed in section 3 are likely influencing its external position.

6. Summary Table – Key Drivers

7. Quick Revision Questions

1. Explain how a strong domestic currency can lead to a current account deficit.
2. Identify two policy measures a government could adopt to reduce a persistent current account deficit.
3. Why might a country with large overseas investments experience a current account surplus?