Balance of Payments
Senior 6 · Economics
Balance of Payments
Lesson 3 of 4
25 min
In 2023 Rwanda's current account deficit widened to US$1,647 million, from US$1,240 million in 2022 (BNR). Demand for dollars to pay for imports outran the supply, and the Rwandan franc lost value quickly: by the end of December 2023 it had depreciated by 18.05% against the US dollar in a year. Floods in May 2023 added to the strain.
On 14 December 2023 the International Monetary Fund (IMF) approved a 14-month Stand-by Credit Facility for Rwanda of SDR 200.25 million (about US$268 million), a loan designed for countries with short-term balance of payments needs. The IMF said the aim was to rebuild buffers and protect macroeconomic stability, alongside a tighter fiscal policy over the medium term.
This case shows the two questions of this lesson: how is a deficit financed in the short run, and how is it corrected in the long run?
Definition
Financing a deficit: finding the foreign currency to pay for a gap between payments and receipts, without removing its cause.
Correcting (adjusting) a deficit: changing the economy so that payments and receipts come closer together, by raising exports or cutting imports.
| Method | Advantage | Limitation |
|---|---|---|
| Running down foreign-exchange reserves | Quick; no new debt | Reserves are limited; below about 4 months of import cover confidence falls |
| Borrowing abroad (commercial loans, bonds) | Large sums available | Interest must be paid (primary income debits rise); debt can become unsustainable |
| Concessional loans and IMF facilities | Low interest; IMF support signals confidence to other lenders | Conditions attached; still debt to repay |
| Grants from donors | No repayment | Unreliable and falling; may carry conditions |
| Attracting FDI and portfolio investment | Brings capital, skills and technology | Profits and interest flow out later; portfolio money can leave suddenly |
| Debt rescheduling or relief | Reduces immediate payments | Harms creditworthiness |
A country with a current account surplus earns more foreign currency than it spends. It can add to its reserves, repay foreign debt early, invest abroad (for example through a sovereign wealth fund), or allow its currency to appreciate. A large, persistent surplus is also a problem: it means the country is consuming less than it produces, it can cause inflation if the foreign earnings are spent at home, and trading partners with matching deficits may retaliate.
Definition
Expenditure-switching policies: policies that switch spending by residents and foreigners away from foreign goods and towards domestic goods, such as devaluation, tariffs and export subsidies.
Expenditure-reducing policies: policies that cut total spending in the economy, and with it spending on imports, such as higher taxes, lower government spending and higher interest rates.
Devaluation: a deliberate reduction by the government or central bank in the value of the currency under a fixed exchange rate. Under a floating rate the same fall, caused by the market, is a depreciation.
| Type | Measures | How they work | Drawbacks |
|---|---|---|---|
| Expenditure switching | Devaluation or depreciation | Exports become cheaper abroad; imports dearer at home | Imported inflation; works only if demand is elastic enough (Marshall–Lerner) |
| Expenditure switching | Tariffs, quotas, import licences | Directly cut imports | Deadweight loss; retaliation; limited by EAC and WTO rules |
| Expenditure switching | Export promotion and subsidies | Raise exports | Cost to the budget; may break trade rules |
| Expenditure reducing | Contractionary fiscal policy (higher taxes, lower spending) | Lower incomes, so fewer imports | Slower growth and more unemployment |
| Expenditure reducing | Contractionary monetary policy (higher interest rates) | Less borrowing and spending; attracts capital inflows | Hurts investment; inflows may reverse |
| Supply-side | Better infrastructure, skills, energy, standards; value addition and diversification | Make exports more competitive and replace imports over time | Slow; expensive; results uncertain |
| Direct controls | Exchange control, rationing of foreign currency | Limit how much can be spent abroad | Black markets, corruption, discourages investors |
In 2022 and 2023 the BNR tightened monetary policy, mainly to bring down inflation (BNR, 2025); higher interest rates also tend to reduce spending on imports.
Worked example
Worked example 1: what a depreciation does to prices (illustrative)
The exchange rate moves from Frw 1,300 to Frw 1,430 per US dollar, a depreciation of
An import priced at US$50 cost ; it now costs . Imports are dearer in Rwanda.
An export of coffee priced at Frw 7,800 per kg cost a foreign buyer
Rwandan exports are cheaper abroad. Whether the trade balance improves depends on how much the quantities respond.
Definition
Marshall–Lerner condition: a depreciation improves the balance of trade only if the sum of the price elasticities of demand for exports and for imports is greater than one (in absolute values, starting from balanced trade):
J-curve: the path of the current account after a depreciation: it first gets worse, because contracts are fixed and buyers take time to switch, and improves later as volumes respond.
Worked example
Worked example 2: testing the Marshall–Lerner condition (illustrative)
A country exports 100 units at US$1.00 and imports 150 units at US$1.00, a trade balance of dollars. A depreciation cuts the dollar price of its exports by 10% and raises the local price of imports by 10% (their dollar price stays at US$1.00).
| Low elasticities: , | High elasticities: , | |
|---|---|---|
| Export volume | ||
| Export earnings (US$) | ||
| Import volume | ||
| Import spending (US$) | 145.5 | 138.0 |
| New trade balance | : worse | : better |
With the depreciation makes the deficit worse; with it improves it. For a country whose imports are mostly fuel, food and machinery, import demand is often inelastic in the short run, which is one reason for the J-curve.
Warning
Devaluation is not a free cure. It raises the local cost of imported fuel, food and inputs (feeding inflation), and it raises the franc value of foreign-currency debt. If inflation then rises as fast as the currency falls, the competitive gain disappears. Always evaluate a devaluation with the Marshall–Lerner condition, the J-curve and the risk of inflation.
Tip
Switch or reduce? If the policy changes which goods people buy (home or foreign), it is expenditure switching. If it changes how much they spend in total, it is expenditure reducing. Supply-side policies change what the country can produce.
Important
Discuss. Rwanda imports mainly fuel, food, machinery and inputs, and exports mainly primary products whose prices are set on world markets. Which combination of the measures in the table would you recommend to reduce its current account deficit over ten years, and why would you reject the others?
EconplusDal, "Policies to Rectify a Current Account Deficit with Evaluation" (about 7 minutes). Expenditure-switching, expenditure-reducing and supply-side policies, each with an evaluation point. Note which of his evaluation points apply to a landlocked, commodity-exporting country.
Practice
Sources and credits
Written by Ganzaa: the J-curve drawing, the tables, the worked examples and the practice items. The prices, quantities and elasticities in the worked examples are illustrative. This lesson adapts CC BY-SA material and is shared under CC BY-SA 4.0.
