The Current Account The balance of the current account tells us if a country has a deficit or a surplus. If there is a deficit, does that mean the economy is weak? Does a surplus automatically mean that the economy is strong? Not necessarily. But to understand the significance of this part of the BOP, we should start by looking at the components of the current account: goods, services, income and current transfers.
<ul><li>Goods - These are movable and physical in nature, and in order for a transaction to be recorded under "goods", a change of ownership from/to a resident (of the local country) to/from a non-resident (in a foreign country) has to take place. Movable goods include general merchandise, goods used for processing other goods, and non-monetary gold. An export is marked as a credit (money coming in) and an import is noted as a debit (money going out). </li></ul>
<ul><li>Services - These transactions result from an intangible action such as transportation, business services, tourism, royalties or licensing. If money is being paid for a service it is recorded like an import (a debit), and if money is received it is recorded like an export (credit). </li></ul>
<ul><li>Income - Income is money going in (credit) or out (debit) of a country from salaries, portfolio investments (in the form of dividends , for example), direct investments or any other type of investment. Together, goods, services and income provide an economy with fuel to function. This means that items under these categories are actual resources that are transferred to and from a country for economic production. </li></ul>
<ul><li>Current Transfers - Current transfers are unilateral transfers with nothing received in return. These include workers' remittances, donations, aids and grants, official assistance and pensions. Due to their nature, current transfers are not considered real resources that affect economic production. </li></ul>
whether the current account is in deficit or surplus (whether it has more credit or debit). This will help us understand where any discrepancies may stem from, and how resources may be restructured in order to allow for a better functioning economy. The following variables go into the calculation of the current account balance (CAB): Theoretically, the balance should be zero X = Exports of goods and services M = Imports of goods and services NY = Net income abroad NCT = Net current transfers CAB = X - M + NY + NCT
A surplus is indicative of an economy that is a net creditor to the rest of the world shows how much a country is saving as opposed to investing What this means is that the country is providing an abundance of resources to other economies, and is owed money in return By providing these resources abroad, a country with a CAB surplus gives other economies the chance to increase their productivity while running a deficit. This is referred to as financing a deficit.
A deficit reflects an economy that is a net debtor to the rest of the world It is investing more than it is saving and is using resources from other economies to meet its domestic consumption and investment requirements let us say an economy decides that it needs to invest for the future (to receive investment income in the long run), so instead of saving, it sends the money abroad into an investment project.
This would be marked as a debit in the financial account of the balance of payments at that period of time, but when future returns are made, they would be entered as investment income (a credit) in the current account under the income section. A current account deficit is usually accompanied by depletion in foreign-exchange assets because those reserves would be used for investment abroad. The deficit could also signify increased foreign investment in the local market, in which case the local economy is liable to pay the foreign economy investment income in the future
As export is a credit to a local economy while an import is a debit, an import means that the local economy is liable to pay a foreign economy. Therefore a deficit between exports and imports (goods and services combined) - otherwise known as a balance of trade deficit (more imports than exports) - could mean that the country is importing more in order to increase its productivity and eventually churn out more exports. This in turn could ultimately finance and alleviate the deficit
A deficit could also stem from a rise in investments from abroad and increased obligations by the local economy to pay investment income (a debit under income in the current account). Investments from abroad usually have a positive effect on the local economy because, if used wisely, they provide for increased market value and production for that economy in the future. This can allow the local economy eventually to increase exports and, again, reverse its deficit So, a deficit is not necessarily a bad thing for an economy, especially for an economy in the developing stages or under reform: an economy sometimes has to spend money to make money
The Capital and Financial Accounts Along with transactions pertaining to non-financial and non-produced assets, the capital account relates to dealings including debt forgiveness, the transfer of goods and financial assets by migrants leaving or entering a country, the transfer of ownership on fixed assets , the transfer of funds received to the sale or acquisition of fixed assets, gift and inheritance taxes, death levies, patents, copyrights, royalties and uninsured damage to fixed assets.
Detailed in the financial account are government-owned assets (i.e. special drawing rights at the International Monetary Fund (IMF) or foreign reserves), private sector assets held in other countries, local assets held by foreigners (government and private), foreign direct investment, global monetary flows related to investment in business, real estate, bonds and stocks.
Capital that is transferred out of a country for the purpose of investing is recorded as a debit in either of these two accounts. This is because money is leaving the economy. But because it is an investment, there is an implied return. This return - whether a capital gain from portfolio investment (a debit under the financial account) or a return made from direct investment (a debit under the capital account) - is recorded as a credit in the current account (this is where income investment is recorded in the BOP). The opposite is true when a country receives capital: paying a return on a said investment would be noted as a debit in the current account.
What Does This Mean? Theoretically, the BOP should be zero. Thus, the current account on one side and the capital and financial account on the other should balance each other out.
When an economy, however, has positive capital and financial accounts (a net financial inflow), the country's debits are more than its credits (due to an increase in liabilities to other economies or a reduction of claims in other countries). This is usually in parallel with a current account deficit; an inflow of money means that the return on an investment is a debit on the current account. Thus, the economy is using world savings to meet its local investment and consumption demands. It is a net debtor to the rest of the world.
If the capital and financial accounts are negative (a net financial outflow), the country has more claims than it does liabilities either because of an increase in claims by the economy abroad or a reduction in liabilities from foreign economies. The current account should be recording a surplus at this stage, indicating that the economy is a net creditor, providing funds to the world