How do you analyze trade and current account balances?

1 Trade balance

The trade balance is the difference between the value of a country's exports and imports of goods and services. A positive trade balance, or a trade surplus, means that a country sells more goods and services to the rest of the world than it buys. A negative trade balance, or a trade deficit, means the opposite. The trade balance is affected by various factors, such as exchange rates, income levels, production costs, demand and supply conditions, trade policies, and competitiveness.

2 Current account balance

The current account balance is the sum of the trade balance, the net income from abroad, and the net transfers from abroad. The net income from abroad is the difference between the income earned by a country's residents from their investments and work abroad and the income paid to foreign residents from their investments and work in the country. The net transfers from abroad are the difference between the transfers received by a country's residents from foreign governments, organizations, or individuals and the transfers paid to foreign residents by the country's government, organizations, or individuals. A positive current account balance, or a current account surplus, means that a country receives more income and transfers from the rest of the world than it pays. A negative current account balance, or a current account deficit, means the opposite.

3 Balance of payments

The balance of payments is a comprehensive record of all the transactions between a country and the rest of the world. It consists of two main accounts: the current account and the capital account. The capital account records the net flows of financial assets and liabilities, such as loans, bonds, stocks, direct investment, and reserves. The balance of payments must always balance, meaning that the sum of the current account and the capital account must be zero. This implies that any surplus or deficit in the current account must be matched by an equal and opposite surplus or deficit in the capital account.

4 Exchange rate effects

The exchange rate is the price of one currency in terms of another currency. It influences the trade and current account balances by affecting the relative prices of goods and services, the competitiveness of exports and imports, and the value of income and transfers denominated in foreign currencies. A depreciation of a country's currency means that its goods and services become cheaper for foreign buyers, while foreign goods and services become more expensive for domestic buyers. This tends to increase the country's exports and reduce its imports, improving its trade and current account balances. Conversely, an appreciation of a country's currency means that its goods and services become more expensive for foreign buyers, while foreign goods and services become cheaper for domestic buyers. This tends to reduce the country's exports and increase its imports, worsening its trade and current account balances.

5 Sustainability and adjustment

The trade and current account balances reflect the saving and investment decisions of a country's residents, as well as the availability and cost of external financing. A trade or current account deficit implies that a country is spending more than it is earning, or investing more than it is saving, and relying on borrowing or selling assets to finance the gap. A trade or current account surplus implies that a country is earning more than it is spending, or saving more than it is investing, and lending or buying assets to cover the excess. The sustainability of a trade or current account balance depends on whether it can be financed without causing excessive debt accumulation, asset depletion, or exchange rate instability. The adjustment of a trade or current account balance depends on whether it can be corrected by changes in relative prices, income levels, consumption patterns, production structures, or policy measures.

6 Policy implications

The trade and current account balances have important implications for a country's economic growth, stability, and welfare. They affect the availability and cost of external resources, the allocation and efficiency of domestic resources, the distribution of income and wealth, and the exposure to external shocks and risks. They also have implications for international cooperation, coordination, and conflict. Therefore, policymakers need to monitor and manage the trade and current account balances by using appropriate fiscal, monetary, exchange rate, trade, and structural policies to achieve their economic objectives and obligations.

7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?