CURRENT ACCOUNT OF

BALANCE OF PAYMENTS

Chapter 39 By Juhi Samanta

 WHAT IS BALANCE OF PAYMENTS?

• The balance of payments is a record of all economic

transactions between the residents of a country and the
rest of the world in a particular period.
• These transactions are made by individuals, firms and the
government.
• Money coming into the country is recorded as credit
items and money leaving the country as debit items.
 COMPONENTS OF CURRENT
ACCOUNT

• Trade in goods. This covers exports and imports of goods.

• Trade in services. This part records payments for services sold
abroad and expenditure on services bought from foreign
countries.
• If import expenditure exceed export revenue, then the country
is in a trade deficit.
• If export revenue exceed import expenditure, then the country
is in a trade surplus.
INCOMES
 PRIMARY INCOME SECONDARY INCOME

• This is income earned by individuals and • This is transfers of money, goods or services
firms- basically from trade of goods and which are sent out of the country or come
services. into the country, not in return for anything
else, basically as a gift.
-Wages and salaries earned by residents
working abroad. -Remittances sent by individuals working
abroad to their families back home.
-Earnings from investments abroad, such as
interest, dividends, and profits. -Foreign aid, grants, and donations provided by
governments to other countries.
-Income from leasing land or natural resources
to non-residents. • An Indian worker in the USA sends money
back home to support their family. This
• An Indian engineer works remotely for a
remittance is recorded as personal
company in the USA. The salary he earns
transfers in India’s secondary income.
from this job is recorded as compensation
of employees in India's primary income.
 QUESTION

A country has the following economic data for a given year:

Exports of goods: $500 million
Imports of goods: $600 million
Exports of services: $200 million
Imports of services: $150 million
Net income from abroad: $50 million
Net current transfers: $30 million
 ANSWER:

Current Account Balance=(500−600)+(200−150)+50+30

Current Account Balance=−100+50+50+30
Current Account Balance=30 million
WHY DO CHANGES IN EXPORTS
AND IMPORTS OCCUR?
• Inflation rates: If the country has a relatively high rate of inflation, domestic households and firms are likely
to buy a significant number of imports. This is likely because of its expensive to produce domestically, and
firms may become internationally uncompetitive.
• Exchange rate: When a country’s exchange rate falls, its exports become cheaper for other countries, and
imports become more expensive. This usually leads to an increase in exports and a decrease in imports.
(visa versa) When a country’s exchange rate rises, its exports become more expensive for other countries,
and imports become cheaper. This usually leads to a decrease in exports and an increase in imports.
• Labour productivity: When workers in a country become more productive, the cost of making products goes
down, making them cheaper. As a result, more people and businesses will buy these cheaper domestic
products, leading to an increase in exports and a decrease in imports.
• Domestic GDP: When domestic GDP and incomes rise, people and businesses buy more, including imports.
Firms may purchase more raw materials and equipment from abroad, and households will buy more
imported products. Increased domestic demand might also lead some local firms to focus on the home
market instead of exporting, which could reduce exports.
• Trade restrictions: A relaxation in trade restrictions abroad will make it easier for domestic firms to sell their
products to other countries.
• Foreign GDP: If incomes abroad rise, foreigners will buy more productsQuality
• Marketing
 THE CAUSES AND
CONSEQUENCES OF A
CURRENT ACCOUNT DEFICIT
 CAUSES CONSEQUENCES
• High exchange rates: Will make exports • Fall in exchange rate- as there’ll be a reduction
uncompetitive on inflationary pressure, because there’ll be a
fall in aggregate demand. The reduction in
• Economic Growth: Rapid economic growth inflationary pressure can be caused by lower
can lead to higher domestic consumption, output and unemployment- because less goods
increasing imports if domestic production are produced domestically. This an cause, in
can’t meet demand. the long term, GDP to fall if the issue isn’t
• Deficit in primary income (If a country pays fixed.
more in wages, interest, dividends, and If a trade deficit is caused by a increase in
profits to foreign firms and workers than it imports of capital goods, its likely to be short
receives, it results in a primary income term and self correcting. This is because the
deficit) or secondary income (If a country capital goods will be used to make consumer
sends more in remittances, foreign aid, and goods and services, which’ll cause output, and
other transfers to other countries it'll cause a consequently exports, in the long run.
trade deficit). HOWEVER, if the trade deficit is caused
because of lack of international
competitiveness, like domestic producton costs
are too high, then the deficit may persist as
other economies may take advantage of this
and export their own goods at lower rates.
THE CAUSES AND CONSEQUENCES
OF A CURRENT ACCOUNT SURPLUS
 CAUSES CONSEQUENCES
• Low exchange rates- will make exports more • This'll cause an increase in aggregate
competitive. demand, which’ll result in higher real GDP
and higher employment- which'll be caused
• High quality of domestic products.
by higher output.
• High income of foreigners- this’ll make
• May cause demand pull inflation.
exports more attractive to them as they’ll be
more affordable. • May result in appreciation of exchange rate.
• Low cost of production.
• High secondary and primary income:
Domestic banks, companies, and people
might be making more money from their
investments abroad. More remittances may
be coming in as more people are working
aboard.
POLICIES TO ACHIEVE BALANCE
OF PAYMENTS STABILITY
 MEASURES TO CORRECT A CURRENT
ACCOUNT DEFICIT

• Devaluation of Exchange Rate: Lowering the value of the national currency makes exports
cheaper and imports more expensive, encouraging more exports and reducing imports.
• Reducing Domestic Consumption: Implementing tight fiscal policies, such as higher taxes or
reduced government spending, can decrease domestic consumption and spending on imports.
• Import Restrictions: Imposing tariffs, quotas, or other restrictions on imports can reduce the
volume of imports.
• Monetary Policy Adjustments: Increasing interest rates can reduce domestic spending and
borrowing, which in turn can lower imports.
• Encouraging Foreign Investment: Attracting foreign direct investment can increase the inflow of
capital, improving the current account balance

Literally opposite for correct a

trade surplus
POP QUIZ!
WHAT IS INCLUDED IN THE PRIMARY
A CURRENT ACCOUNT
INCOME OF THE CURRENT ACCOUNT? DEFICIT OCCURS WHEN:

• a) Exports of goods • a) Exports exceed imports

• b) Imports of services • b) Imports exceed exports
• c) Compensation of employees • c) Foreign investments increase
and investment income
• d) Domestic savings increase
• d) Government transfers
 WHICH MEASURE CAN HELP WHAT IS THE EFFECT OF AN
CORRECT A CURRENT ACCOUNT OVERVALUED EXCHANGE RATE ON
DEFICIT? THE CURRENT ACCOUNT?

• a) Devaluation of the national • a) Increases exports

currency
• b) Decreases imports
• b) Increasing export subsidies
• c) Leads to a current account
• c) Reducing government surplus
spending
• d) Leads to a current account
• d) All of the above deficit
 TRUE OR FALSE

True or False: A rise in domestic True or False: Reducing tariffs on

GDP typically leads to an increase imports can help correct a current
in imports. account surplus.

True or False: A current account True or False: Personal transfers

surplus means a country is are a part of primary income in the
exporting more than it is current account.
importing.
 SHORT ANSWERS

• Explain how a fall in a country’s exchange rate can affect its

current account balance.
• Describe the difference between primary income and
secondary income in the current account.
• What are some common causes of a current account deficit?
• How can a country attract foreign direct investment to improve
its current account balance?
• What measures can be taken to correct a current account
surplus?