Balance of payments records all economic transactions with the rest of the world.
It consists of the current account and the capital account.
The current account tracks trade in goods and services, income, and transfers.
A trade deficit occurs when imports exceed exports.
Consequently, the current account shows a negative balance.
To finance this gap, a country must borrow from abroad or sell assets.
Therefore, inflows appear in the capital account.
Moreover, the capital account records foreign investment and loans.
However, a persistent trade deficit can increase foreign debt.
As a result, pressure may build on the domestic currency.
If confidence falls, the currency can weaken.
Consequently, imports become more expensive, which may raise inflation.
Governments can try to reduce the deficit by raising tariffs, offering subsidies, or adjusting exchange rates.
In addition, short‑term deficits can reflect strong domestic demand.
Nevertheless, large and growing deficits can limit a country’s ability to service its debt.
Ultimately, the balance of payments must balance.
Thus, any current‑account deficit is matched by a capital‑account surplus.
Understanding this link helps policymakers manage the economy.