Balance of trade

The balance of trade (or net exports, sometimes symbolized as NX) is the difference between
the monetary value of exports and imports of output in an economy over a certain period. It is the
relationship between a nation's imports and exports. A positive balance is nown as a trade
surplus if it consists of exportin! more than is imported" a ne!ative balance is referred to as a
trade deficit or, informally, a trade !ap. The balance of trade is sometimes divided into a !oods
and a services balance.
The balance of trade forms part of the current account, which includes other transactions such as
income from the international investment position as well as international aid. If the current
account is in surplus, the country's net international asset position increases correspondin!ly.
#$ually, a deficit decreases the net international asset position.
The trade balance is identical to the difference between a country's output and its domestic
demand (the difference between what !oods a country produces and how many !oods it buys
from abroad" this does not include money re%spent on forei!n stoc, nor does it factor in the
concept of importin! !oods to produce for the domestic maret).
&easurin! the balance of trade can be problematic because of problems with recordin! and
collectin! data. As an illustration of this problem, when official data for all the world's countries
are added up, exports exceed imports by almost '(" it appears the world is runnin! a positive
balance of trade with itself. This cannot be true, because all transactions involve an e$ual credit
or debit in the account of each nation. The discrepancy is widely believed to be explained by
transactions intended to launder money or evade taxes, smu!!lin! and other visibility problems.
)owever, especially for developed countries, accuracy is liely.
*actors that can affect the balance of trade include+
The cost of production (land, labor, capital, taxes, incentives, etc.) in the exportin!
economy vis--vis those in the importin! economy"
The cost and availability of raw materials, intermediate !oods and other inputs"
#xchan!e rate movements"
&ultilateral, bilateral and unilateral taxes or restrictions on trade"
,on%tariff barriers such as environmental, health or safety standards"
The availability of ade$uate forei!n exchan!e with which to pay for imports" and
-rices of !oods manufactured at home (influenced by the responsiveness of supply)
Balance of Payments
Balance of payments (BOP) accounts are an accountin! record of all monetary transactions between a
country and the rest of the world. These transactions include payments for the country's exports and
imports of !oods, services, financial capital, and financial transfers. The ./- accounts summarize
international transactions for a specific period, usually a year, and are prepared in a sin!le currency,
typically the domestic currency for the country concerned. 0ources of funds for a nation, such as exports
or the receipts of loans and investments, are recorded as positive or surplus items. 1ses of funds, such as
for imports or to invest in forei!n countries, are recorded as ne!ative or deficit items.
2hen all components of the ./- accounts are included they must sum to zero with no overall surplus or
deficit. *or example, if a country is importin! more than it exports, its trade balance will be in deficit, but
the shortfall will have to be counter%balanced in other ways 3 such as by funds earned from its forei!n
investments, by runnin! down central ban reserves or by receivin! loans from other countries.
2hile the overall ./- accounts will always balance when all types of payments are included, imbalances
are possible on individual elements of the ./-, such as the current account, the capital account excludin!
the central ban's reserve account, or the sum of the two. Imbalances in the latter sum can result in surplus
countries accumulatin! wealth, while deficit nations become increasin!ly indebted. The term 4balance of
payments4 often refers to this sum+ a country's balance of payments is said to be in surplus (e$uivalently,
the balance of payments is positive) by a certain amount if sources of funds (such as export !oods sold
and bonds sold) exceed uses of funds (such as payin! for imported !oods and payin! for forei!n bonds
purchased) by that amount. There is said to be a balance of payments deficit (the balance of payments is
said to be ne!ative) if the former are less than the latter.
Current account
In economics, the current account is one of the two primary components of the balance of
payments, the other bein! the capital account. The current account is the sum of the balance of
trade (exports minus imports of !oods and services), net factor income (such as interest and
dividends) and net transfer payments (such as forei!n aid).
The current account balance is one of two ma5or measures of the nature of a country's forei!n
trade (the other bein! the net capital outflow). A current account surplus increases a country's net
forei!n assets by the correspondin! amount, and a current account deficit does the reverse. .oth
!overnment and private payments are included in the calculation. It is called the current account
because !oods and services are !enerally consumed in the current period.
The balance of trade is the difference between a nation's exports of !oods and services and its
imports of !oods and services, if all financial transfers, investments and other components are
i!nored. A ,ation is said to have a trade deficit if it is importin! more than it exports.
-ositive net sales abroad !enerally contributes to a current account surplus" ne!ative net sales
abroad !enerally contributes to a current account deficit. .ecause exports !enerate positive net
sales, and because the trade balance is typically the lar!est component of the current account, a
current account surplus is usually associated with positive net exports. This however is not
always the case with secluded economies such as that of Australia featurin! an income deficit
lar!er than its trade deficit.
The net factor income or income account, a sub%account of the current account, is usually
presented under the headin!s income payments as outflows, and income receipts as inflows.
Income refers not only to the money received from investments made abroad (note+ investments
are recorded in the capital account but income from investments is recorded in the current
account) but also to the money sent by individuals worin! abroad, nown as remittances, to
their families bac home. If the income account is ne!ative, the country is payin! more than it is
tain! in interest, dividends, etc.
The various subcate!ories in the income account are lined to specific respective subcate!ories
in the capital account, as income is often composed of factor payments from the ownership of
capital (assets) or the ne!ative capital (debts) abroad. *rom the capital account, economists and
central bans determine implied rates of return on the different types of capital. The 1nited
0tates, for example, !leans a substantially lar!er rate of return from forei!n capital than
forei!ners do from ownin! 1nited 0tates capital.
In the traditional accountin! of balance of payments, the current account e$uals the chan!e in net
forei!n assets. A current account deficit implies a paralleled reduction of the net forei!n assets.
6urrent account 7 chan!es in net forei!n assets
Action to reduce a substantial current account deficit usually involves increasin! exports (!oods
!oin! out of a country and enterin! abroad countries) or decreasin! imports (!oods comin! from
a forei!n country into a country). *irstly, this is !enerally accomplished directly throu!h import
restrictions, $uotas, or duties (thou!h these may indirectly limit exports as well), or subsidizin!
exports. Influencin! the exchan!e rate to mae exports cheaper for forei!n buyers will indirectly
increase the balance of payments. Also, 6urrency wars, a phenomenon evident in post
recessionary marets is a protectionist policy, whereby countries devalue their currencies to
ensure export competitiveness. 0econdly, current account deficit are reduced by promotin!
investor friendly environment, i.e., forei!n direct investment (*8I), forei!n institutional
investors (*II), the income from these forei!n investments positively contributes to current
account. Thirdly, ad5ustin! !overnment spendin! to favor domestic suppliers is also effective.
9ess obvious methods to reduce a current account deficit include measures that increase
domestic savin!s (or reduced domestic borrowin!), includin! a reduction in borrowin! by the
national !overnment.
Capital account
In &acroeconomics and international finance, the capital account (also nown as financial
account) is one of two primary components of the balance of payments, the other bein! the
current account. 2hereas the current account reflects a nation's net income, the capital account
reflects net chan!e in national ownership of assets.
A surplus in the capital account means money is flowin! into the country, but unlie a surplus in
the current account, the inbound flows will effectively be borrowin!s or sales of assets rather
than earnin!s. A deficit in the capital account means money is flowin! out the country, but it also
su!!ests the nation is increasin! its claims on forei!n assets.
The term 4capital account4 is used with a narrower meanin! by the International &onetary *und
(I&*) and affiliated sources. The I&* splits what the rest of the world calls the capital account
into two top level divisions+ financial account and capital account, with by far the bul of the
transactions bein! recorded in its financial account.
At hi!h level+
.reain! this down+
*orei!n direct investment (*8I) , refers to lon! term capital investment such as the
purchase or construction of machinery, buildin!s or even whole manufacturin! plants. If
forei!ners are investin! in a country, that is an inbound flow and counts as a surplus item on
the capital account. If a nation's citizens are investin! in forei!n countries, that's an outbound
flow that will count as a deficit. After the initial investment, any yearly profits not re%
invested will flow in the opposite direction, but will be recorded in the current account rather
than as capital.
-ortfolio investment refers to the purchase of shares and bonds. It's sometimes !rouped
to!ether with 4other4 as short term investment. As with *8I, the income derived from these
assets is recorded in the current account" the capital account entry will 5ust be for any
international buyin! or sellin! of the portfolio assets.
/ther investment includes capital flows into ban accounts or provided as loans. 9ar!e
short term flows between accounts in different nations are commonly seen when the maret
is able to tae advanta!e of fluctuations in interest rates and : or the exchan!e rate between
currencies. 0ometimes this cate!ory can include the reserve account.
;eserve account. The reserve account is operated by a nation's central ban to buy and
sell forei!n currencies" it can be a source of lar!e capital flows to counteract those
ori!inatin! from the maret. Inbound capital flows (from sales of the account's forei!n
currency), especially when combined with a current account surplus, can cause a rise in
value (appreciation) of a nation's currency, while outbound flows can cause a fall in value
(depreciation). If a !overnment (or, if authorized to operate independently in this area, the
central ban itself) doesn't consider the maret%driven chan!e to its currency value to be in
the nation's best interests, it can intervene.
Central Bank operations and the reserve account
6onventionally, central bans have two principal tools to influence the value of their nation's
currency+ raisin! or lowerin! the base rate of interest and more effectively by the buyin! or
sellin! of their currency. 0ettin! a hi!her interest rate than other ma5or central bans will tend to
attract in funds via the nation's capital account, and this will act to raise the value of its currency.
A relatively low rate will have the opposite effect. 0ince 2orld 2ar II, interest rates have lar!ely
been set with a view to the needs of the domestic economy and, anyway, chan!in! the interest
rate alone has only a limited effect.
A nation's ability to prevent its own currency fallin! in value is limited mainly by the size of its
forei!n reserves+ it needs to use the reserves to buy bac its currency. In contrast, there are no
immediate limits preventin! a nation from preventin! its currency from risin! in value % as it 5ust
needs to sell its own currency, and can always print more in order to do this % however this can
cause inflation if additional miti!ation measures are not implemented and can lead to political
pressure from other countries if they consider the nation is main! its exports excessively
competitive. A third mechanism that 6entral .ans and !overnments can use to raise or lower
the value of their currency is simply to tal it up or down, by hintin! at future action that may
discoura!e speculators.
<uantitative easin! (Q.E.) , a practice used by ma5or central bans in =>>?, is a mechanism that
can exert a one way downwards pressure on a country's currency, althou!h officially Q.E. has
been deployed 5ust to boost the domestic economy. As an example of direct intervention to
mana!e currency valuation, in the =>th century @reat .ritain's central ban, the .an of
#n!land, would sometimes use its reserves to buy lar!e amounts of pound 0terlin! to prevent it
fallin! in value % .lac 2ednesday was a case where it had insufficient reserves of forei!n
currency to do this successfully. 6onversely, 6hina in the early ='st century has effectively sold
lar!e amounts of ;enminbi in order to prevent its value risin! % and in the process buildin! lar!e
reserves of forei!n currency, principally the dollar.
0ometimes the reserve account is classed as 4below the line4 and so not reported as part of the
capital account. *lows to or from the reserve account can substantially affect the overall capital
account. Tain! a!ain the example of 6hina in the early ='st century, then excludin! the activity
of its central ban, 6hina's capital account had a lar!e surplus as it had been the recipient of
much forei!n investment. If the reserve account is included however, 6hina's capital account has
been in lar!e deficit as its central ban purchased lar!e amounts of forei!n assets (chiefly 10
!overnment bonds) to a de!ree sufficient to offset not 5ust the rest of the capital account, but its
lar!e current account surplus as well.
Sterilization
In the financial literature, sterilization is a term commonly used to refer to a central ban's
operations which miti!ate the potentially undesirable effects of inbound capital % currency
appreciation and inflation. 8ependin! on the source, sterilization can mean the relatively
strai!htforward re%cyclin! of inbound capital to prevent currency appreciation and:or a wide
ran!e of measures to chec the inflationary impact of inbound capital. The classic way to
sterilize the inflationary effect of the extra money flowin! into the domestic base from the capital
account is for the central ban to use open maret operations where it sells bonds domestically,
thereby soain! up new cash that would otherwise circulate around the home economy. A central
ban normally maes a small loss from its overall sterilization operations, as the interest it earns
from buyin! forei!n assets to prevent appreciation is usually less than what it has to pay out on
the bonds it issues domestically to chec inflation. )owever in some cases a profit can be made.
In the strict text boo definition, sterilization refers only to measures aimed at eepin! the
domestic monetary base stable % an intervention to prevent currency appreciation that involved
merely buyin! forei!n assets without counteractin! the resultin! increase of the domestic money
supply would not count as sterilization.
Capital controls
6apital controls are measures imposed by a state's !overnment aimed at mana!in! capital
account transactions. They include outri!ht prohibitions a!ainst some or all capital account
transactions, transaction taxes on the international sale of specific financial assets, or caps on the
size of international sales and purchases of specific financial assets. 2hile usually aimed at the
financial sector, controls can affect ordinary citizens, for example in the '?A>s .ritish families
were at one point restricted from tain! more than BC> with them out of the country for their
forei!n holidays. 6ountries without capital controls that limit the buyin! and sellin! of their
currency at maret rates are said to have full 6apital Account 6onvertibility.