<6.4 CURRENT ACCOUNT & BALANCE OF PAYMENTS>

--STRUCTURE OF THE CA--

The CURRENT ACCOUNT is a RECORD that shows the INCOME RECEIVED by a country and the EXPENDITURE MADE by it in its dealings with other countries. Money INFLOWS are recorded as CREDIT items and money OUTFLOWS as DEBIT items.

"We can see below the breakdown of the UK's current account in Q2 2025", "Can you identify the largest section?"

"Let's use the UK's current account as our reference point."

--SECTION 1 :TRADE IN GOODS--

"Whenever we sell exports, we receive an inflow."

This covers exports and imports of GOODS, including CARS, FOOD, and MACHINERY. Such goods are sometimes referred to as MERCHANDISE or VISIBLE EXPORTS and IMPORTS.
🚨IMPORTANT: The goods do not need to be explicitly 'Made in HK'; however, the exporter must be a resident of Hong Kong with the transaction being between them and a non-resident involving a change of ownership of goods.
EXPORT REVENUE is an INFLOW / CREDIT ITEM (+)
IMPORT EXPENDITURE is an OUTFLOW / DEBIT ITEM (-) on the CA.
- - - - If EXPORT REVENUE is 'GREATER THAN' the IMPORT EXPENDITURE, the country is said to have a TRADE IN GOODS SURPLUS.
      - If EXPORT REVENUE is 'LESS THAN' the IMPORT EXPENDITURE, the country is said to have a TRADE IN GOODS DEFICIT.

--TASK--

"Create three columns like the ones below in your notebook and enter 3 credit and debit items, like my example below. Use your own real-world examples."

⚠️"You will be uploading your complete current account to a padlet so keep it neat!!! ⚠️

--SECTION 2: TRADE IN SERVICES--

"Whenever we sell exports, we receive an inflow."

This covers exports and imports of SERVICES including BANKING, TRAVEL, and FINANCIAL SERVICES. Such services are sometimes referred to as INVISIBLE EXPORTS & IMPORTS.
- EXPORT REVENUE is an INFLOW / CREDIT ITEM (+) on the CA.
- IMPORT EXPENDITURE is an OUTFLOW / DEBIT ITEM (-) on the CA.
  - - - If EXPORT REVENUE is 'GREATER THAN' the IMPORT EXPENDITURE, the country is said to have a TRADE IN SERVICES SURPLUS.
        If EXPORT REVENUE is 'LESS THAN' the IMPORT EXPENDITURE, the country is said to have a TRADE IN SERVICES DEFICIT.

--TASK--

--SECTION 3: PRIMARY INCOME--

The PRIMARY INCOME section of the current account records all the flows between residents and non-residents that result from the OWNERSHIP OF FACTORS OF PRODUCTION:

- - WAGES & SALARIES FROM THE OWNERSHIP OF LABOUR: This component records income earned by residents for work performed abroad (an export of labor services) and income earned by non-residents for work performed within the domestic economy (an import of labor services). A key characteristic is that the employee is working in an economy where they are not a resident (i.e., they stay for less than one year).
    - - Example: A Hong Kong engineer works for an MNC based in the United States for 5 months. The engineer receives a monthly salary of $5,000 for their work. This salary is considered wages earned by the HK resident from employment abroad (export of the labour services of a HK resident). It would be recorded as a credit in HK's primary income account.
  - PROFITS & DIVIDENDS FROM THE OWNERSHIP OF ASSETS: This component accounts for INCOME EARNED by residents from their investments in foreign companies, including profits, dividends, and retained earnings. Similarly, it includes income earned by non-residents from their investments in domestic companies.
    - - Example: A HK investor owns shares in an MNC headquartered in Europe. The company declares an annual dividend of $2 per share, and the investor owns 1,000 shares. Therefore, the investor receives $2,000 in dividends from their investment. This dividend income represents profits and dividends earned by a HK resident from their investment in a foreign company and would be recorded as a credit item in HK's primary income account.
  - INTEREST INCOME FROM THE OWNERSHIP OF LIABILITIES: This part of the primary income section records INCOME EARNED by residents from their ownership of financial assets (such as bonds and loans) issued by foreign entities and income earned by non-residents from their ownership of financial assets issued by domestic entities.
    - - Example: A HK individual holds government bonds issued by the United Kingdom. The bonds pay an annual interest rate of 3%, and the individual holds $50,000 worth of bonds. Therefore, the individual earns $1,500 in interest income ($50,000 * 3%). This interest income represents income earned by a HK resident from their ownership of financial assets issued by a foreign entity and would be recorded as a credit item in HK's primary income account.
  - RENTAL INCOME FROM THE OWNERSHIP OF PROPERTY: This component includes INCOME EARNED by residents from the use of their property or natural resources by non-residents (such as rent from foreign-owned properties) and income earned by non-residents from the use of property or natural resources owned by residents.
    - - Example: A HK landlord rents out an apartment to an expatriate family from the UK. The monthly rent for the apartment is $2,500. Therefore, the landlord earns $2,500 per month in rental income from the property. This rental income represents income earned by a HK resident from the use of their property by non-residents and would be recorded as a credit item in HK's primary income account.
The PRIMARY INCOME BALANCE, refers to the 'NET FLOW OF PRIMARY TRANSFERS'.

--TASK--

--SECTION 4: SECONDARY INCOME--

These refer to TRANSFERS of money, goods or services which are sent out of the country or come into the country, NOT IN RETURN FOR ANYTHING ELSE. For example GIFTS, CHARITABLE DONATIONS, AID and REMITTANCES (Payments from people living and working overseas and sending money back to country of origin, in other words NON-EARNED INCOME).
The SECONDARY INCOME BALANCE, refers to the 'NET FLOW OF SECONDARY TRANSFERS'.

--TASK--

ANSWER:

TRADE IN GOODS = $19,618m - $24,900m = -$5,282

TRADE IN SERVICES = $2,121m - $4,074 = -$1,953

a) BALANCE OF TRADE IN G & S = -$7235

TRADE IN GOODS $1,041,438 - $1,075,850 = -$34,412

TRADE IN SERVICES $191,656 - $197,643 = -$5,987

PRIMARY -$100,366

SECONDARY - $33,533

b) CA BALANCE = -$174,298m

--THINK AHEAD--

"With all these inflows and outflows, it is unlikely that they will balance, and there regularly exist 'deficits' and 'surpluses'. can you think of a link between exchange rates and

--CAUSES--

TRADE BALANCE (X-M)

--DEFICIT (X<M)--

--SURPLUS (X>M)--

--HIGH INFLATION--

When the economy's RELATIVE INFLATION RATE RISES, then their EXPORTS BECOME MORE EXPENSIVE, while IMPORTS become CHEAPER hence WORSENING the trade balance.

--LOW INFLATION--

When the economy's RELATIVE INFLATION RATE FALLS, then their EXPORTS BECOME CHEAPER, while IMPORTS become MORE EXPENSIVE, hence IMPROVING the trade balance.

--RISING X-RATE--

A RISING (Appreciating or Revalued) exchange rate will make EXPORTS MORE EXPENSIVE and IMPORTS CHEAPER, hence WORSONING the trade balance.

--FALLING X-RATE--

A FALLING (Depreciating or Devalued) exchange rate will make EXPORTS CHEAPER and IMPORTS more EXPENSIVE, hence IMPROVING trade balance.

--RISING DOM. GDP--

When DOM. INCOME INCREASES, there is naturally a greater level of consumer spending, which includes MORE IMPORTS, and without an equal increase in exports, the trade balance will WORSEN.

--RISING FOREIGN GDP--

When FOREIGN INCOME INCREASES, they naturally have a GREATER DEMAND for your EXPORTS (Their imports) hence the trade balance will IMPROVE.

--FREE TRADE--

The FEWER BARRIERS TO TRADE (The 'freer the trade'), a country has, the MORE COMPETITION they will face from IMPORTS, hence the spending on IMPORTS may RISE, however, it could also be true that EXPORTS also RISE, so the trade balance may WORSEN or IMPROVE.

--PROTECTONISM--

The MORE BARRIERS TO TRADE, a country has E.G. TARIFF, the MORE EXPENSIVE IMPORTS become, hence the trade balance may IMPROVE however, it could also be true that other countries may also erect barriers and EXPORTS will FALL, so the trade balance may WORSEN or IMPROVE.

--LOWER PRODUCTIVITY--

The LESS PRODUCTIVE a country’s workers are, the HIGHER the labour COSTS PER UNIT and THE MORE EXPENSIVE ITS PRODUCTS. A FALL in PRODUCTIVITY, therefore, is likely to lead to LESS domestic and foreign demand – so EXPORTS should FALL and IMPORTS RISE thus WORSENING the trade balance.

--RISING PRODUCTIVITY--

The MORE PRODUCTIVE a country’s workers are, the LOWER the labour COSTS PER UNIT and THE CHEAPER ITS PRODUCTS. A RISE in PRODUCTIVITY, therefore, is likely to lead to MORE domestic and foreign demand – so EXPORTS should RISE and IMPORTS FALL thus IMPROVING the trade balance.

--FALLING QUALITY--

A FALL IN RELATIVE QUALITY of a country’s products,, would have an ADVERSE effect on the country’s balance of trade in goods and services, as EXPORTS will FALL, and IMPORTS will RISE, hence WORSENING the trade balance.

--RISING QUALITY--

A RISE IN RELATIVE QUALITY of a country’s products,, would have an POSITIVE effect on the country’s balance of trade in goods and services, as EXPORTS will RISE, and IMPORTS will FALL, hence IMPROVING the trade balance.

--TASK--

"Explain three causes of a deficit in the trade balance."

PRIMARY INCOME

--DEFICIT--

--SURPLUS--

--NEG. INVEST INCOME--

The combined investment income (Interest + Profits + Dividends) EARNED FROM ABROAD (credits) are LESS THAN the combined investment income of foreigners SENT ABROAD (debits)

--POS. INVEST INCOME--

The combined investment income (Interest + Profits + Dividends) EARNED FROM ABROAD (credits) are GREATER THAN the combined investment income of foreigners SENT ABROAD (debits).

--NEG. WORKERS COMP.--

HK workers' wages and salaries earned overseas and sent back to HK WERE MORE THAN the wages and salaries earned by foreigners working in HK and sent back to their home countries.

--POS. WORKERS COMP.--

HK workers' wages and salaries earned overseas and sent back to HK WERE LESS THAN the wages and salaries earned by foreigners working in HK and sent back to their home countries.

--TASK--

"Explain why there might be a surplus in the primary income balance."

SECONDARY INCOME

--DEFICIT--

--SURPLUS--

--NEG. REMITTANCES--

The economy’s workers working abroad may be sending LESS money home to relatives than foreign migrant workers are sending to their relatives.

--POS. REMITTANCES--

The economy’s workers working abroad may be sending MORE money home to relatives than foreign migrant workers are sending to their relatives.

--TASK--

"Find a real-world example of a country with a surplus on its secondary income balance."

--CONSEQUENCES

--DEFICIT--

--LOW GDP--

A CA DEFICIT implies a FALL in NX, which is a component of AD, hence GDP will FALL.

--LOW EMPLOYMENT--

FALLING GDP, means FEWER workers are needed hence HIGHER UNEMPLOYMENT.

--LOW INFLATION--

FALLING GDP, means LESS AD, hence putting DOWNWARD PRESSURE on the AVERAGE PRICE LEVEL reducing INFLATION.

--DEPRECIATION--

As NX FALLS, there is LESS DEMAND for the country's EXPORTS, hence there is LESS DEMAND for its CURRENCY, leading to a DEPRECIATION.

--TASK--

"Using the 'consequences of a CA Deficit' above, explain how a CA SURPLUS impacts economic objectives"

--6.4.4 STABILISING POLICIES--

--DEFICIT--

--SURPLUS--

-REDUCE IMPORT SPENDING-

"How do we get you to spend LESS on 'IMPORTS'?"

METHOD#1:

"Make imports more expensive relative to domestic goods.",

By 'RAISING TRADE BARRIERS', which will make imports more expensive.
By 'LOWERING THE EXCHANGE RATE' (depreciating or devaluing) to make imports more expensive in your currency.

METHOD#2:

"Reduce domestic incomes so people spend less on imports."

By using 'CONTRACTIONARY FISCAL & MONETARY POLICY' (Higher income taxes and interest rates), will lower disposable income and, as a result, reduce spending on imports

METHOD#3:

"Make our domestic versions cheaper than imports"

By using 'SUPPLY-SIDE POLICIES' such as investments in technology, they can INCREASE PRODUCTIVITY to IMPROVE THE QUALITY OF DOMESTIC GOODS as well as LOWER AVERAGE COSTS, making them more competitive compared to imported versions, helping to reduce demand for imports.

-INCREASE IMPORT SPENDING (TASK)-

--TASK--

"How do we get you to spend MORE on 'IMPORTS'?"

Use the methods in the 'reduce import spending' section to help you answer this question.

--INCREASE EXPORT REVENUE (TASK)--

--TASK--

"How do we get foreigners to spend MORE on our 'EXPORTS'?"

Use the methods in the 'decrease export revenue' section to help you answer this question. Also, can you comment on how you can use 'SUPPLY-SIDE POLICIES' to increase your exports.

--DECREASE EXPORT REVENUE--

"How do we get foreigners to spend LESS on our 'EXPORTS'?"

METHOD#1:

"Make exports more expensive."

By 'RAISING THE EXCHANGE RATE' (appreciating or revaluing), making exports more expensive in terms of foreign currencies.

--PAST PAPERS--

--PAPER 1--

--MCQ--

The answer is 'D', we can see that in year 1, China had slightly more exports than imports, and hence had a trade SURPLUS however in year 2 exports were less than imports, therefore they had a trade DEFICIT.

-REDUCE IMPORT SPENDING-

"How do we get you to spend less on 'made overseas'?"

METHOD#1:

"Let's make imports more expensive relative to domestic goods.",

By 'RAISING TRADE BARRIERS', which will make imports more expensive.
By 'LOWERING THE EXCHANGE RATE' (depreciating or devaluing) to make imports more expensive in your currency.

METHOD#2:

"Let's reduce domestic incomes so people spend less on imports."

By using 'CONTRACTIONARY FISCAL & MONETARY POLICY' (Higher income taxes and interest rates), will lower disposable income and, as a result, reduce spending on imports

METHOD#3:

"Let's make our domestic versions cheaper than imports"

By using 'SUPPLY-SIDE POLICIES' such as investments in technology, they can INCREASE PRODUCTIVITY to IMPROVE THE QUALITY OF DOMESTIC GOODS as well as LOWER AVERAGE COSTS, making them more competitive compared to imported versions, helping to reduce demand for imports.

-INCREASE IMPORT SPENDING-

-DECREASE TRADE BARRIERS: TARIFFS, QUOTAS ETC TO MAKE IMPORTS CHEAPER

-RAISE THE EXCHANGE RATE TO MAKE IMPORTS CHEAPER IN DOMESTIC CURRENCY.

-EXPANSIONARY FISCAL & MONETARY POLICY (LOWER INCOME TAX AND INTEREST RATES) TO RAISE DISPOSABLE INCOME AND INCREASE SPENDING ON IMPORTS.

--LOW GDP--

A CA DEFICIT implies a FALL in NX, which is a component of AD, hence GDP will FALL.

--HIGH GDP--

A CA SURPLUS implies a RISE in NX, which is a component of AD, hence GDP will RISE.

--LOW EMPLOYMENT--

FALLING GDP, means FEWER workers are needed hence HIGHER UNEMPLOYMENT.

--HIGH EMPLOYMENT--

RISING GDP, means MORE workers are needed hence LOWER UNEMPLOYMENT.

--LOW INFLATION--

FALLING GDP, means LESS AD, hence putting DOWNWARD PRESSURE on the AVERAGE PRICE LEVEL reducing INFLATION.

--HIGH INFLATION--

RISING GDP, means MORE AD, hence putting UPWARD PRESSURE on the AVERAGE PRICE LEVEL increasing the risk of DEMAND-PULL INFLATION.

--DEPRECIATION--

As NX FALLS, there is LESS DEMAND for the country's EXPORTS, hence there is LESS DEMAND for its CURRENCY, leading to a DEPRECIATION.

--APPRECIATION --

As NX RISES, there is MORE DEMAND for the country's EXPORTS, hence there is MORE DEMAND for its CURRENCY, leading to a APPRECIATION.

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