Balance of Payments

Lessons

Senior 6 · Economics

Balance of Payments

4 lessons

Lesson 4 of 4

Causes of change and the terms of trade

25 min

Three shocks in the data

Rwanda's balance of payments moves every year, often for reasons far from Kigali. The BNR's figures record three recent shocks:

Shock	What the BNR data show
A pandemic closes borders	Travel (tourism) receipts were only US$120 million in 2020, the first year of COVID-19. They recovered to US$400 million in 2022 and US$564 million in 2023.
World oil prices jump	The value of energy imports rose by 84% in 2021–22 and by a further 48% in 2022–23.
Coffee prices swing	Coffee export earnings fell by 32.1% in 2023–24, then rose by 47.6% in 2024–25; the average price received fell by 17.3% and then rose by 18.6%.

Think: which of these shocks could Rwanda's government have prevented? Which could it only prepare for?

Definition

Cyclical imbalance: a deficit or surplus caused by the business cycle at home or abroad, such as a boom that sucks in imports. It tends to reverse when the cycle turns.

Structural imbalance: a persistent deficit caused by deep features of the economy, such as a narrow export base, low productivity or dependence on imported fuel. It does not correct itself.

External shock: an event outside the country's control that changes its trade, such as a pandemic, a war or a change in world commodity prices.

Causes of changes in the balance of payments

Cause	Effect on the current account	Rwandan illustration
Faster growth of incomes at home	More imports of consumer and capital goods: worsens	The BNR linked the wider 2024 deficit to strong domestic activity and demand for capital goods
Faster growth of incomes abroad	More demand for exports: improves	Regional demand for re-exports
Changes in world prices (terms of trade)	Dearer imports or cheaper exports worsen it, and the reverse	Oil prices in 2022; coffee prices in 2023–25
Exchange rate changes	A depreciation can improve it after a delay (J-curve)	The franc fell 18.05% against the dollar in 2023
Inflation higher than trading partners'	Exports lose competitiveness: worsens
Productivity and quality	Better quality and lower costs improve it	Value addition in tea and coffee processing
Natural disasters, pandemics, conflict	Lost exports, extra imports: worsen	Tourism in 2020; floods in May 2023
Changes in remittances and grants	Move the secondary income balance	Budget grants fell while remittances rose
Interest rates and investor confidence	Move the financial account, and so the reserves	FDI inflows rose from US$233 million (2021) to US$595 million (2025)

How the terms of trade affect the balance of payments

Recall from Unit 1 that the terms of trade compare export prices with import prices. A change in them feeds straight into the current account, but the size and even the direction of the effect depend on how quantities respond.

A price-taking commodity exporter. Rwanda is too small to change the world price of coffee, tea or tin. When the world price rises, it can sell at the higher price and producers supply more, so export earnings rise: the terms of trade and the balance of payments improve together (see the diagram).
A country that sets its own export prices. If a rise in export prices comes from higher domestic costs, and foreign demand is price-elastic, buyers switch to rivals and export earnings fall: the terms of trade "improve" but the current account worsens.
A rise in import prices worsens the terms of trade. If import demand is inelastic, as for fuel, spending on imports rises and the current account worsens.

Worked example

Worked example 1: price effect and volume effect for coffee (BNR data)

In 2023–24 Rwanda exported 16,479 tonnes of coffee at an average US$4.78 per kg; in 2024–25 it exported 20,509 tonnes at US$5.67 per kg. Split the rise in earnings into its two causes (1 tonne = 1,000 kg):

Price effect (the old volume sold at the new price):

16\,479 \times 1\,000 \times (5.67 - 4.78) \approx 14.7 \text{ million US dollars}

Volume effect (the extra tonnes, at the new price):

(20\,509 - 16\,479) \times 1\,000 \times 5.67 \approx 22.9 \text{ million US dollars}

Together about US$37.6 million, close to the BNR's recorded rise from US$78.7 million to US$116.2 million (the small gap comes from rounding the prices). About 39% of the gain came from the world price and about 61% from the bigger harvest.

Worked example

Worked example 2: a fuel price shock (illustrative, based on the BNR's 2024–25 import bill)

Rwanda's energy imports were worth US$705.1 million in 2024–25. Suppose the world price of fuel rises by 10% and, because demand is inelastic ( $|\mathrm{PED}| = 0.2$ ), the quantity imported falls by only $0.2 \times 10\% = 2\%$ .

\text{New fuel bill} = 705.1 \times 1.10 \times 0.98 \approx 760.1 \text{ million US dollars}

The fuel bill rises by about $760.1 - 705.1 = 55.0$ million dollars, and the current account deficit widens by the same amount unless something else changes. If the price of Rwanda's exports is unchanged, its terms of trade deteriorate at the same time.

Warning

Don't say "better terms of trade always improve the balance of payments". Say what caused the change. A rise in world demand for the country's exports improves both. A rise in export prices caused by domestic inflation, with elastic demand, can worsen the current account while the terms of trade index rises.

Tip

Price × quantity. Every change in export earnings or import spending is a change in price, a change in quantity, or both. Split it (as in worked example 1) before you explain it.

Important

Discuss. Of the three shocks at the start of this lesson, the pandemic, the oil price rise and the coffee price swings, which one does Rwanda's commercial policy (diversifying exports and adding value) do most to protect against? Which needs a different response, such as larger reserves or cleaner energy at home?

EconplusDal, "Primary Commodities Price Volatility - Causes and Consequences" (about 5 minutes). Why the prices of goods like coffee and minerals swing so much, and what that means for the countries that export them.

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Practice

Distinguish between a cyclical and a structural current account deficit.
Give five causes of a deterioration in a country's current account, with a Rwandan example of at least two.
A country exports 10,000 tonnes of tea at US$2.80 per kg. The next year it exports 11,000 tonnes at US$3.00 per kg. Calculate (a) the change in export earnings, (b) the price effect at the old volume and (c) the volume effect at the new price.
A country's fuel imports are US$400 million. The world price rises by 25% and the quantity imported falls by 5%. Find the new fuel bill.
Using a diagram, explain why a rise in the world price of a commodity raises the export earnings of a small exporting country.
Explain how an improvement in the terms of trade could worsen the current account.
"Rwanda's balance of payments problems are caused by events outside its control." Evaluate.

Show answersHide answers

A cyclical deficit comes from the business cycle (a boom raising imports) and reverses when the cycle turns; a structural deficit comes from lasting features such as a narrow export base or dependence on imported fuel, and persists.
For example: fast growth at home raising imports (2024); higher import prices such as oil (2022); lower export prices such as coffee (2023–24); pandemics and disasters (tourism in 2020; floods in 2023); higher inflation than trading partners; falling grants.
(a) Before: $10\,000 \times 1\,000 \times 2.80 = 28$ million dollars; after: $11\,000 \times 1\,000 \times 3.00 = 33$ million; change $+ 5$ million. (b) $10\,000 \times 1\,000 \times 0.20 = 2$ million. (c) $1\,000 \times 1\,000 \times 3.00 = 3$ million. $2 + 3 = 5$ .
$400 \times 1.25 \times 0.95 = 475$ million US dollars.
The country is a price taker: it sells all it wants at the world price. A higher price raises earnings on existing output and draws out more supply (a movement along S from Q1 to Q2), so earnings rise from area A to area A + B.
If export prices rise because domestic costs rise, and foreign demand is price-elastic, the fall in quantity sold outweighs the higher price, so export earnings fall while the terms of trade index rises.
Partly true: pandemics, oil and coffee prices and floods are external. But structural causes are domestic: a narrow export base, dependence on imported fuel and food, low productivity and rising debt payments, which policy can change over time. A good answer weighs both and concludes.

1Three shocks in the data

2Causes of changes in the balance of payments

3How the terms of trade affect the balance of payments

Three shocks in the data

Causes of changes in the balance of payments

How the terms of trade affect the balance of payments