Current Account Balance of Payments

Meaning of Current Account Balance of Payment

The current account balance of payment is one of the two main parts of the balance of payments accounts. It records the transactions that relate to the import and export of goods and services across the borders of the nation over a specific period of time. The transactions are usually with multiple countries, and hence involve a complex mix of exchange of foreign currency. The domestic country receives foreign exchange from countries to which it exports goods and services. It pays foreign exchange to the countries from which it imports.

Apart from goods and services, the current account also includes unilateral transfers and investment income and payments between the domestic country and one or many foreign countries. Unilateral transfers are one-way transactions and can be in the form of donations, gifts, remittances of personal nature, etc. Investment income and payments may comprise of rentals, interest, profits from investments, etc.

We also call the difference between the sum of all exports of goods and services of a country and its total imports over that specific time period the Balance of Trade. It does not include unilateral transfers and the investment income or payments between the nations. A favorable or a positive current account balance indicates that the export of goods and services of a country is more than its imports. At the same time if the current account balance is negative or unfavorable then it denotes that the country is having more imports and its dependency on imports is high. Therefore, countries strive to achieve a favorable current account balance so that they become net earners of foreign exchange. It is an indicator of its strength and competency in the global arena and helps to keep the value of its currency strong.

Main Components of Current Account Balance of Payments

We have four main components of the current account balance of payments. Let us look at them in detail.

Tangibles

Tangibles in the current account are goods that we can touch and see, possess physically and transfer the ownership when the need arises. Countries export the goods in which they specialize. Specialization along with economies of scale results in higher productivity and lower costs of production. Good quality products at low prices help the nations to compete with the products of other countries and capture their markets. By exporting more the country accumulates more of the foreign currency and remains comfortable to pay back for its imports.

Countries import those tangibles in which they either do not specialize or lack the required resources. Also, they may be better off by importing that product rather than making it on their own due to cost differences. Some of the common goods that countries export and import are textiles, machinery, IT hardware and accessories, automobiles, mobile telephony, etc. Every country tries to be a net exporter of goods so that it earns more foreign currency and it does not have to rely upon other countries for its consumable goods. However, despite trying their best it is not always possible for all the countries to keep the exports higher than their imports.

We record the exports or receipts of the foreign exchange on the credit side of the current account. Imports or remittance of foreign exchange is recorded on the debit side of the current account.

Intangibles or Services

Countries import and export intangibles in the form of services. We cannot touch and see them, but receive the socio-economic benefits out of them. In the times of knowledge economy, countries make use of such specialized services so as to stay ahead of the competition by making use of modern technology as well as human expertise. Some examples of cross-border services that countries use are shipping, banking, insurance, software development, etc.

Current Account Balance of Payment

In the case of an intangible, it is possible that a country specializes in a particular field of service. The residents may have a special skill set that makes it logical to use their service in foreign countries, even at a higher price. This will be known as the export of services. Similarly, the country may use the services of people from other countries. They may have the expertise, technical know-how, or speed and accuracy that the domestic people might not have. Hence, the country will import these services to use at home.

Similar to goods, we record the export of services on the credit side of the current account as it marks the inflow of foreign currency. We record the import of services on the debit side of the current account as the currency will flow out of the country for making payments.

Unilateral Transfers

We also call these transfers one-way or one-sided transactions. Residents of a country either send it to a resident of another country or receive its benefit from a foreign resident. The receipt of the benefit is one-way, and no service or product is offered in return. Such transfers include gifts, donations, foreign aid, remittances that people send back home, etc.

In the current account, we make a credit entry while receiving a unilateral transfer from abroad. We will make a debit entry in the current account while making a unilateral transfer to another country.

Investment Income and Payments

Investment incomes and payments are directly related to the number of investments held in different countries. These investments comprise real estate, securities, bank deposits, and reserves of the central bank and the governments. Asset incomes and payments that flow from one country to another are in the form of rents, interest, dividends, salaries, and profits.

What is More Beneficial in the Current Account Balance of Payments –a Surplus or Deficit?

The current account records the receipts of foreign exchange on the credit side. Any outflow of currency to other countries is recorded on the debit side. There will be a current account surplus if the exports are more than the imports. Similarly, if imports are more than the exports then the current account will show a deficit.

Usually, a current account deficit may mean that an economy is underperforming or is not competitive with regard to foreign competition. Residents start importing more which is not good for the economy. But there may be a silver lining to it as domestic consumption increases which may spur growth. However, in order to correct the current account deficits, governments generally attract foreign capital investment in the country. This may shift the ownership of domestic assets in the hands of foreigners. Also, more money will flow out of the country in the form of rentals and dividends.

Therefore, a current account surplus is favorable under most circumstances. It is an indicator of the good performance of the economy with regard to foreign competition. But one has to be careful about the circumstances under which it is favorable. Sometimes, there may be a drop in economic activity and the imports and exports both may go drastically low. The exports may still be a bit higher than the imports. It may show a current account surplus, while the overall level of economic activities may not be good for the economy. Thus, we need to deal with both the situations of deficit and surplus judiciously and in the best interests of the economy.

Frequently Asked Questions (FAQs)

What do we mean by the current account balance of payment?

A Balance of Payment crisis is a situation when a country is not in a position to pay even for its basic imports.

What are the main components of the current account balance of payments?

The main components of the current account balance of payments include:
1. Tangibles
2. Intangibles or services
3. Unilateral transfers
4. Investment incomes and payments

What is more beneficial in the current account Balance of Payments –a surplus or deficit?

Current account surplus is favorable and preferred under most circumstances – an indicator of the good performance of the economy with regard to foreign competition.

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Sanjay Borad

Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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