The causes and consequences of a deficit and a surplus on the current account of the balance of payments

The causes and consequences of a deficit on the current account of a balance of payments A deficit occurs when more money is leaving the country than coming in. This is when imports of goods and services as well as income and transfer payments abroad exceed exports and income and transfer payments coming in to the country. A deficit can arise out of two reasons, one is that the countrys residents are buying more abroad than overseas residents have spent on the countrys products. This may be due to a changing exchange rate. If the domestic currency, say the British pound has appreciated over the U dollar, it becomes cheaper for U! residents to buy U exports and more expensive for the U to buy U! exports. Another cause for a deficit on the trade of goods and services is changes in income. If people in the U! have an increase in income, they can afford to buy more goods, some of which may be imports. imilarly, if the U saw a fall in general income levels, they will buy less products which will decrease imports. Structural problems can also lead to a deficit in trades in goods and services. This is where domestic firms are producing poor "uality goods and are inefficient. If this is the case, demand is li#ely to fall and a deficit will persist. If there has been a large transfer of income abroad, this will lead to a current account deficit. Individuals may invest in the U! and reap the benefits and profits gained and ta#e it bac# to their homes. This is influenced by a number of factors such as the amount invested, the amount of profit

The causes and consequences of a deficit and a surplus on the current account of the balance of payments
The causes and consequences of a deficit on the current account of a balance of payments A deficit occurs when more money is leaving the country than coming in. This is when imports of goods and services as well as income and transfer payments abroad exceed exports and income and transfer payments coming in to the country. A deficit can arise out of two reasons, one is that the countrys residents are buying more abroad than overseas residents have spent on the countrys products. This may be due to a changing exchange rate. If the domestic currency, say the British pound has appreciated over the U dollar, it becomes cheaper for U! residents to buy U exports and more expensive for the U to buy U! exports. Another cause for a deficit on the trade of goods and services is changes in income. If people in the

U! have an increase in income, they can afford to buy more goods, some of which may be imports. imilarly, if the U saw a fall in general income levels, they will buy less products which will decrease imports. Structural problems can also lead to a deficit in trades in goods and services. This is where domestic firms are producing poor "uality goods and are inefficient. If this is the case, demand is li#ely to fall and a deficit will persist. If there has been a large transfer of income abroad, this will lead to a current account deficit. Individuals may invest in the U! and reap the benefits and profits gained and ta#e it bac# to their homes. This is influenced by a number of factors such as the amount invested, the amount of profit gained and interest earned. A deficit will decrease aggregate demand and lead to a contraction along aggregate supply. This will lower an economys output, increase unemployment but reduce the general price level. A rise in the deficit may also increase international borrowing as well as lead to a fall on the exchange rate. The causes and consequences of a surplus on the current account of the balance of payments A surplus on the other hand is when there is more money entering the country. This is when the exports and transfers inward exceed the levels of imports and transfers abroad. This can occur when export revenue exceeds import expenditure and$or when the country invests successfully abroad and transfers investment income bac# home. The country is li#ely to have a surplus in the short run when the exchange rate is in their favour. A reduction in the price of domestic goods attracts foreign customers. A falling exchange rate also raises the price of imports and this may lead to a surplus in the current account. If firms produce high "uality products which match consumer demand, then this will also contribute to the current account surplus. A surplus however may exist when there is a recession % two consecutive "uarters of negative growth. &irms may find difficulty selling products domestically so will compete vigorously in export markets instead. A strong inflow of income has the conse"uence of increasing the money supply. Ban#s have more money to lend and this creates a multiplier effect. 'ore investment from ban#s can occur which means aggregate demand will increase and this will have the additional effect of pushing up the exchange rate. The significance of the current account performance A deficit or surplus that is small and last for a short time will bear little significance as it will not have much impact on aggregate demand. A deficit may indicate a healthy and growing economy, some economies are in the process of switching the main production from primary sector wor#, such as agriculture, to secondary sector wor#, such as manufacturing. This re"uires new e"uipment from abroad which, while in the short run leads to deficit, in the long run this will improve the countrys economy. A current account deficit may also be influenced by the other sectors of the balance of payments. The U! for instance has long had a current account deficit but has a strong capital account surplus to balance this.
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gained and interest earned. A deficit will decrease aggregate demand and lead to a contraction along aggregate supply. This will lower an economys output, increase unemployment but reduce the general price level. A rise in the deficit may also increase international borrowing as well as lead to a fall on the exchange rate. The causes and consequences of a surplus on the current account of the balance of payments A surplus on the other hand is when there is more money entering the country. This is when the exports and transfers inward exceed the levels of imports and transfers abroad. This can occur when export revenue exceeds import expenditure and$or when the country invests successfully abroad and transfers investment income bac# home. The country is li#ely to have a surplus in the short run when the exchange rate is in their favour. A reduction in the price of domestic goods attracts foreign customers. A falling exchange rate also raises the price of imports and this may lead to a surplus in the current account. If firms produce high "uality products which match consumer demand, then this will also contribute to the current account surplus. A surplus however may exist when there is a recession % two consecutive "uarters of negative growth. &irms may find difficulty selling products domestically so will compete vigorously in export markets instead. A strong inflow of income has the conse"uence of increasing the money supply. Ban#s have more money to lend and this creates a multiplier effect. 'ore investment from ban#s can occur which means aggregate demand will increase and this will have the additional effect of pushing up the exchange rate. The significance of the current account performance A deficit or surplus that is small and last for a short time will bear little significance as it will not have much impact on aggregate demand. A deficit may indicate a healthy and growing economy, some economies are in the process of switching the main production from primary sector wor#, such as agriculture, to secondary sector wor#, such as manufacturing. This re"uires new e"uipment from abroad which, while in the short run leads to deficit, in the long run this will improve the countrys economy. A current account deficit may also be influenced by the other sectors of the balance of payments. The U! for instance has long had a current account deficit but has a strong capital account surplus to balance this.
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Balance of (ayments ) *eficits and urpluses

Author: Geoff Riley Last updated: Sunday 23 September, 2012 What does a current account deficit mean? +unning a deficit on the current account means that an economy is not paying its way in the global economy. There is a net outflow of demand and income from the circular flow of income and spending. pending on imported goods and services exceeds the income from exports. Balance of payments and the standard of living In principle, there is nothing wrong with a trade deficit. It simply means that a country must rely on foreign direct investment or borrow money to ma#e up the difference In the short term, if a country is importing a high volume of goods and services this is a boost to living standards because it allows consumers to buy more consumer durables.

Balance of Payments and Aggregate emand ,hen there is a current account deficit % this means that there is a net outflow of demand and income from a countrys circular flow. In other words, trade in goods and services and net flows from transfers and investment income are ta#ing more money out of the economy than is flowing in. Aggregate demand will fall. ,hen there is a current account surplus there is a net inflow of money into the circular flow and aggregate demand will rise. Wider !conomic !ffects of a "urrent Account eficit # Trade $mbalances

"ountries %ith Trade Surpluses

'any countries operate with a trade and current account surplus % good examples are -hina, .ermany, /apan, 0orway and emerging mar#et countries with strong export sectors.

There are several causes and each country will have a uni"ue set of circumstances1 !xport&oriented gro%th1 ome countries have set out to increase the capacity of their export industries as a growth strategy. Investment in new capital provides the means by which economies of scale can be exploited, unit costs driven down and comparative advantage can be developed. 'oreign direct investment1 trong export growth can be the result of a high level of foreign direct investment where foreign affiliates establish production plants and or exporting. (ndervalued exchange rate1 A trade surplus might result from a country attempting to depreciate its exchange rate to boost competitiveness. !eeping the exchange rate down might be achieved by currency intervention by a nations central ban#, i.e. selling their own currency and accumulating reserves of foreign currency. 2ne of the persistent disputes between the U A and -hina has revolved around allegations that the -hinese have manipulated the 3uan so that export industries can continue to sell huge volumes into 0orth American mar#ets. )igh domestic savings rates1 ome economists attribute current account surpluses to high levels of domestic savings and low domestic consumption of goods and services. -hina has a high household saving ratio and a huge trade surplus4 in contrast the savings ratio in the United tates has collapsed and their trade deficit has got bigger. -ritics of countries with persistent trade surpluses argue they should do more to expand domestic demand to boost world trade. "losed economy % some countries have a low share of national income ta#en up by imports % perhaps because of a range of tariff and non)tariff barriers. Strong investment income from overseas investments1 A part of the current account that is often overloo#ed is the return that investors get from purchasing assets overseas % it might be the profits

coming home from the foreign subsidiaries of multinational businesses, or the interest from money held on overseas ban# accounts, or the dividends from ta#ing e"uity sta#es in foreign companies.

Policies # approaches to reduce a persistent current account deficit

There are a number of policies that can be introduced to achieve an improvement in a countrys trade balance % some of them focus on changing the growth of demand, others loo# to improve the supply) side competitiveness of an economy. As with any macroeconomic 5problem effective policies are those that target the underlying causes. 6. emand management1 +eductions in government spending, higher interest rates and higher taxes could all have the effect of dampening consumer demand reducing the demand for imports. This leads to an increase in spare productive capacity which can then be allocated towards exporting. 7. *atural effects of the economic cycle1 2ne would expect to see a trade deficit fall during a recession % so some of the deficit is partially self)correcting % but this does little to address the problems of a structural balance of payments problem. 8. A lo%er exchange rate1 a. The central ban# of a country might decide that a lower exchange rate provides a suitable way of improving competitiveness, reducing the overseas price of exports and ma#ing imports more expensive b. &or those countries operating with a managed exchange rate, the government may decide to authorise intervention in the currency mar#ets to manipulate the value of the currency 9. Supply&side improvements1 a. (olicies to raise productivity, measures to bring about more innovation and incentives to increase investment in industries with export potential are supply)side measures designed to boost exports performance and compete more effectively with imports. The time)lags for supply)side policies to have an impact are long. b. (olicies to encourage business start)ups % successful small businesses with export potential c. Investment in education and health)care to boost human capital and increase

competitiveness in fast)growing and high value industries such as bio)technology, engineering, finance, medicine d. Investment in modern critical infrastructure to support businesses and industries involved in international mar#ets :. Protectionist measures such as import "uotas and tariffs are rarely used because of our commitments to the ,orld Trade 2rganisation and our membership of the ;uropean Union.

"ase Study+ The BoP in Argentina+ efault, evaluation and a -anaged !xchange .ate System

In 6<<6, Argentina abandoned a fixed exchange rate against the U dollar, ended their currency board and moved to a managed floating exchange rate. There was an immediate devaluation of the currency % devaluation means that one U dollar buys more Argentinean peso. By the autumn of 7==7, the peso had stabilised against the U dollar at close to 8 peso to >6. ,as the devaluation a boost to the economy? In theory a lower exchange rate represents an expansionary monetary policy ) exports are cheaper overseas, imports become more expensive, there ought to be a boost to domestic demand and a recovery in growth because the Argentinean economy will have become more competitive in world mar#ets In the short run, the devaluation of the peso made the recession worse and led to a loss of capital from the economy. 7==7 was the 9th consecutive year of recession for Argentina. In 7==7, there was an 66@

fall in national output % that on its own is sufficient to be called a depression. The currency collapse caused a worsening of Argentinas terms of trade, the nation effectively became poorer measured in U dollars per capita. *evaluation caused a sharp spi#e in inflation Arising above 7=@B because imports became more expensive. This caused deep cuts in peoples real incomes giving less purchasing power Cigher inflation led to a steep rise in mar#et interest rates in Argentina % this cut consumer demand and business investment. 'oney mar#et interest rates pea#ed close to 9=@. Dower spending cost thousands of Eobs The return of inflation to Argentina worsened the problem of extreme poverty especially with mass unemployment and a huge rise in imported food prices The collapse in the current caused capital flight from Argentina. Investors too# fright and move their money elsewhere. ;ffectively Argentina became isolated in the global capital mar#ets.

;conomic recovery started a few years later and the economy then experienced a significant improvement in her balance of payments $ trade data. In the case of Argentina, the fundamental reason for improving trade has been high global prices for many of her maEor export commodities. These commodities tend to have an inelastic demand A(edF6B so when world prices are rising, export revenues from selling cereals, soy beans and other primary products to the rest of world increase mar#edly. Argentina has moved from trade deficit to trade surplus in goods over the last fifteen years as favourable world prices have allowed her to benefit from her comparative advantage. Trade has been an engine of economic growth for them. +ising export demand is an inEection of aggregate demand. And an extra inflow of income intro the circular flow can

generate higher investment in export industries and in supply)chain businesses that prosper when exports are strong. A competitive exchange rate has helped Argentina to achieve rapid economic growth % indeed the government deliberately manages the exchange rate to aid export industries. But a significantly lower exchange rate has also brought costs % in particular, a persistently high rate of domestic inflation. Cigh rates of inflation threaten to undermine the competitiveness of the economy. And they also create widespread social and political pressures not least demands for compensating wage increases as people see# to protect their real incomes. .rowth has been strong but it is also coming at a cost % a significant increase in the cost of living. &ew people believe the accuracy of Argentinean economic statistics % officially inflation is around 6=@ but this is held down artificially by complex systems of subsidies for fuel, energy and foodstuffs. 'any economists believe that the true rate of inflation in Argentina is 7=@ or more.

Argentinas strong growth has helped to bring down the national unemployment rate from 7=@ of the labour force in 7==7 to 6=@ in 7==: and now Eust under G@ in 7=66. ;ven during the growth slowdown in 7==< the unemployment rate nudged higher only by a small margin. Although another devaluation of the peso at the end of 7==6 caused a steep spi#e in public sector debt Amuch of which was borrowed in U dollarsB. (ublic sector debt has fallen below :=@ of .*( since 7==H and the country has also reduced her external debts. But Argentina still owes over >Gbn to western governments and shows few signs of being willing to repay outstanding debts from before the default in 7==6. Argentina is in default on >H.<bn in loans to foreign governments, including .ermany, /apan,

the U , the 0etherlands, and Italy.

$ndia/s current account deficit shrinks to 0123 of 4 P

teps ta#en by the government to curb imports of non)essential items, especially gold, start showing
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*eath and despair in hailstorm)hit 'arathwada

The message in opinion polls since last /uly

 igns of nervousness in Indian mar#ets

Do# abha polls1 Joter turnout stays high in phase 8 Indias 7=78 bonds complete biggest wee#ly gain since /anuary

,hile merchandise exports were up 67@ to >H6.7 billion in the "uarter, imports declined 9.H@ to >669.: billion. (hoto1 +aE#umar$'int *e% elhi+ Indias current account deficit narrowed sharply in the "uarter ended eptember as the impact of the governments measures to curb imports of non)essential items, especially gold, #ic#ed in, signalling that pressure on the countrys external sector is receding. To be sure, slower economic growth and the conse"uent drop in imports are also responsible for the fall, which means less pressure on the rupee. The currency has depreciated 66.G:@ against the dollar since 6 /anuary, and ended on 'onday at K7.87 to the dollar. The current account deficitLthe sum of the balance of trade and invisibles such as remittances and software earningsLfell to 6.7@ of gross domestic product in the /uly) eptember "uarter of the current fiscal, the lowest level since the fourth "uarter of 7=6=)66. It was 9.<@ in the fiscal first "uarter ended /une and :@ a year ago for the "uarter ended eptember. Together with the improved gross domestic product numbers, the drop in the current account deficit is the best piece of macroeconomic news India has seen in some time, suggesting that the economy may have bottomed out. *ata released last wee# showed that economic growth accelerated to 9.H@ in the second "uarter from 9.9@ in the preceding "uarter, aided by higher growth in industry and agriculture and a pic#)up in exports. The government is hoping that the economy will grow at :@ in the current fiscal. Balance of payments data released by the +eserve Ban# of India A+BIB almost a month earlier than expected showed that the sharp fall was mainly on account of a lower trade deficit as imports, especially of gold, fell sharply and exports rose.

Indias current account deficit rose to 9.H@ of .*( in 7=67)68, much above the governments comfort level of 7.:)8@ of .*(. ,hile merchandise exports were up 67@ to >H6.7 billion in the "uarter on the bac# of growth in shipments of textiles, leather and chemical products, imports declined 9.H@ to >669.: billion. .old imports in the "uarter were at >8.< billion, as against >6K.9 billion in the first "uarter and >66.6 billion in the year)ago period. Improvement in services exports helped in increasing net invisibles, further aiding the fall in the current account deficit. 0et services exports were up 67.:@ at >6H.9 billion. &inance minister (. -hidambaram, while reacting to the numbers, said that the balance of payments position had improved significantly and expressed confidence that the current account deficit will remain within targets. The government hopes to contain the current account deficit in the current fiscal at >K= billion. In the first half of the fiscal, the current account deficit stood at >7K.< billion, an indication that the government may manage to meet its target. M;xternal sector ris#s have abated. ,e are less vulnerable now and this is good news for the rupee as well,N said hubhada +ao, chief economist at 3es Ban# Dtd. MThe trade gap will remain range)bound and we expect the current account deficit for the full year to be around >:= billion or around 7.:)8@ of .*(,N she said. MThe domestic macroeconomic data is also loo#ing better. The second "uarter .*( number was better than expected. This is expected to further improve in the second half of the fiscal. o there are more positives than negatives,N she added. The Indian rupee gained 68 paise against the dollar and ended the day at K7.87 a dollar. The government, however, did not receive ade"uate capital flows to fund the current account deficit in the "uarter. Though there was a net inflow of >K.< billion on account of foreign direct investment, there was an outflow of >K.K billion on account of portfolio flows as tal#s of tapering by the U &ederal +eserve saw foreign institutional investors pulling out funds. 0+Ideposits, however, were up sharply at >H.8 billion from >7.H billion in the year ago period. There was a drawdown of >6=.9 billion from the countrys foreign exchange reserves to fund the deficit. +ao said that steps ta#en by +BI to attract non)resident deposits should ensure that financing the current account deficit in the coming "uarters should not be a problem. In eptember, the central ban# had announced that it would subsidise the hedging cost of foreign currency swaps for ban#s offering 0+I deposits. Abhee# Barua, chief economist at C*&- Ban# Dtd, said the fall in the current account deficit was more than expected. MA fall was expected given the low gold demand and a sharp pic#)up in exports. But the magnitude of this fall can be attributed to considerable support from software exports and private transfers,N he said. M,ith these numbers, the full year current account deficit should be around >:= billion or around 7.G)7.H@ of .*(,N he added. (TI contributed to this story. 7: &irst (ublished1 'on, *ec =7 7=68. =: 7H (' I T -urrent Account *eficit O7 .*( .old Imports Also +ead
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$ndia/s industrial output shrinks 0153 in 'ebruary

i4ate/s first&quarter profit falls 53

AAP focusing on local issues in 6arnataka+ Balakrishnan

-inority .eport 7 *obody %atches the %atchmen

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The rise of 8irat 6ohli The great 4u9arat gro%th debate :ok Sabha polls+ 8oter turnout stays high in phase ; Where $s The Wealthy $ndian Buying )ome S" refuses plea questioning S$T clean chit to *arendra -odi

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Photo !ssay 7 )oly Spirit "hurch

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:ok Sabha polls pick up steam across the country

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elhi goes voting

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:ok Sabha polls begin %ith queues and brisk voting in Assam, Tripura
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!conomic %eakness, not magic %and, the reason for "A fall

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