A country buying more from abroad than it sells must be paying for the difference somehow: borrowing, selling assets, or running down reserves. There is no other possibility, because every transaction has two sides. That accounting truth is the whole of the balance of payments, and it is why a current account deficit is never a standalone fact. It always has a counterpart, and the interesting question is what that counterpart is and whether it can continue.
Balance of payments
A record of all financial transactions between the residents of a country and the rest of the world over a period of time, usually a year.
The current account has four components and questions expect all four. Trade in goods records exports and imports of physical products, sometimes called visible trade. Trade in services records exports and imports of services such as tourism, banking, insurance and shipping, sometimes called invisible trade. Primary income records wages, interest, profits and dividends flowing in and out, so a country whose firms own assets abroad receives inflows here. Secondary income records transfers with nothing given in return, such as foreign aid and money sent home by workers abroad.
Data-response questions routinely give the four components and ask for the current account balance, or give three and the total and ask for the missing one. Set them out in a column with signs, inflows positive and outflows negative, and add. The commonest error is treating the trade in goods balance as the current account balance, when it is only one of four parts and a country with a goods deficit can have a current account surplus.
Calculating the current account balance from its components
A country records: exports of goods $180bn, imports of goods $220bn, exports of services $95bn, imports of services $60bn, net primary income minus $12bn, net secondary income plus $8bn. Calculate the trade in goods balance, the trade in services balance and the overall current account balance.
A current account deficit arises for identifiable reasons. Domestic goods may be uncompetitive because costs or prices are high, quality is poor, or the exchange rate is strong. Rapid domestic growth pulls in imports as incomes rise. A recession in export markets reduces demand for what the country sells. Structural weakness, such as a narrow export base or dependence on a single commodity, leaves a country exposed. And high domestic inflation relative to competitors erodes competitiveness year after year.
A persistent deficit matters, though not always urgently. It must be financed by borrowing from abroad or by selling domestic assets, and both create future obligations: interest to be paid or profits to be repatriated, which worsen the primary income balance later. It can indicate a loss of competitiveness that will cost jobs in export industries. It may put downward pressure on the currency. And if lenders lose confidence, financing can stop suddenly. Against that, a deficit caused by importing capital equipment for investment builds future capacity, and a deficit financed by long-term inward investment is far safer than one financed by short-term borrowing.
A country has a deficit on trade in goods of $50bn and a surplus on trade in services of $70bn. Net primary and secondary income are both zero. The current account is:
Which situation makes a current account deficit least worrying?