• Simply told - What is Trade Deficit? What is Current Account Deficit? What is result of high deficits? What is Balance of Payments?

Ever since U.S. President Donald Trump spoke about the Trade Deficit the country had with the world the words Trade and Current Account Deficit are used very often. What do these terms mean?

An economist friend said, “Trade is only merchandise. Current account includes services, remittances and primary income. Primary income is what the country earns on its foreign assets minus what it pays for its foreign liabilities.”

Simply put a trade deficit takes place when a country imports more of merchandise than it exports. It results in say a USA consumer funding economic investment and incomes in the exporting country.

This adversely affects jobs/economic activity in importing country say USA. That is why Trump wants more U.S. consumed goods to be produced locally. Even though imports mean lower cost/adequate supplies for U.S. consumers.

A country with a trade deficit has to find ways to fund the deficit. In case of consistent deficit it shall need to borrow money from abroad. If the country’s savings rate increases that can fund this deficit. If critical items are imported like semiconductors it has a bearing on national security. Sometimes countries devalue their currencies to boost exports like India did in 1966. 

USA is proposing tariffs to make imported goods expensive and thus discourage their consumption. It is hoped that signing of Free Trade Agreements (FTAs) shall promote U.S. exports and reduce its trade deficit.

Current accounts means trade deficit adjusted for services, remittances and primary income. Services includes I.T. company exports (e.g. Infosys, TCS etc) and Global Capability Centres. Remittances includes from non-resident Indians. USA has replaced the Middle East as India’s largest source of remittances into India. “Primary income is what the country earns on its foreign assets minus what it pays for its foreign liabilities.”

“Thus, current account is a broader measure than trade balance as it also includes income (investment income & compensation of employees) & current transfers. The current account of the BoP provides information not only on international trade in goods, but also on international transactions in services.” Source

Current account deficit can be financed by external assistance or drawdown of foreign exchange reserves.

Inflows or outflows received on Capital Account for a nation would include Foreign Direct Investment by foreign companies, Foreign Portfolio investment, External Commercial Borrowings by companies, Non-resident deposits and Foreign, Aid. When these companies remit monies abroad it is FDI outflows.

A stable country and currency attracts capital and inflows.

Balance of Payments means Net Inflows/Outflows on Capital and Current Accounts. “Balance of Payments (BoP) statistics systematically summaries the economic transactions of an economy with the rest of the World (i.e. transactions between resident & non-resident entities) during a given period.” Source   To read RBI report on India’s BOP in second quarter of 2023-24 

In 1991 India has a Balance of Payment Crisis.

“Foreign Exchange Reserves includes Foreign Currency Assets, Gold, SDRs (Special Drawing Rights) & reserve tranche position (RTP) in the International Monetary Fund (IMF).” Source  

This PDF by the Government of India explains concepts simply and briefly. To read PDF click on PDF

Reference

1. Investopedia

2. What is Trade Deficit

3. How does Trade Deficit affect the economy