Current Account Deficit: Meaning, Causes and More

August 20, 2021

1945

A ‘Current Account’ is a record maintained by every country wherein they record their economic transactions with other countries. The transactions of this account are reviewed at fixed intervals, say, quarterly or yearly. The current account comprises net revenue and interests on loans, investment of capital abroad and other transfers such as donations, foreign aid and remittance.

Changes and imbalances in a country’s Current Account affect the internal functioning of the economy. In the case of highly developed countries such as the United States and China, this imbalance directly or indirectly affects the international economy.

In this article we will learn about these Current Accounts and what happens when they run into a deficit. We will study the related problems and try to understand some solutions that may be applicable.

What is a Current Account Deficit? (CAD)

Current Account Deficit is the difference between a country’s value on export of goods and services to the value of their imports. When the amount spent on imports increases in comparison to the value of exports, this is known as Current Account Deficit (CAD).

CAD may also be understood as the difference between a country’s savings and its investments. The trade deficit is the largest component of the CAD. When imports increase vis-à-vis exports, it is called a trade deficit.

Credit and Debit

The earnings on exports, investments abroad and incoming payments are understood as credits. Conversely, the imports, foreign investments’ earnings in the country and outgoing monetary transfers to other countries are understood as being debits. Therefore, when the debit exceeds credit, it is known as Current Account Deficit.

Current Account Surplus

Current Account Surplus (CAS) refers to the positive current in debit/credit flow. This is due to the balance of exports vis-a-vis imports, favours the scale of exports. Simply put, it is the opposite of the Current Account Deficit. However, prolonged CAS may indicate low demand for a country’s goods abroad or a fall in import of foreign goods.

Balance of Trade

Balance of Trade (BoT) is a concept very closely related to CAD. In fact, people often use it interchangeably. However, there is a small but significant difference between the two. Unlike CAD, Balance of Trade only takes into account the difference between a country’s transactions on import and export of goods and services only. It does not consider other forms of earnings or expenditure, e.g., domestic capital present overseas and such.

Twin Deficits

When a country experiences both CAD and Fiscal Deficit at the same time, it is known as twin deficit. Fiscal Deficits are caused when a country’s (annual) expenditure is more than its (annual) revenue.

Problems Related to Current Account Deficit

When the scale of balance dips towards higher imports, the subsequent CAD results in a number of problems for the country facing it. Although short-term CADs are not extraordinary, when countries run on trade deficits for a long time, certain problems emerge. Some of these problems are:

CADs reflect short-sightedness in economic planning. It means that countries are more focused on short-term production and consumption of goods rather than long-term.
Countries that generally face deficits also run the risk of falling currency value.
Extensive foreign investments in the country show that foreigners have a great(er) claim on domestic assets and capital.
Inability for businesses to borrow from national banks reflects a lack of savings.
When countries are dependent on foreign aid for large periods of time, it adds an additional burden of repaying high-interest loans on the economy.
Alternatively, foreign investors may withdraw their investments after a period of time if they do not see any domestic impetus in trade and economy.

For example, in the short-run investor nations may help out a country facing a deficit. This is favourable for the debtor country because it drives economic growth. However, over longer periods of time, the inability to pay back or lack of growth in the domestic economy may alienate foreign capital.

However, we must remember that CADs impact different countries differently. As aforementioned, short-term deficits are not uncommon. Similarly, CADs in developed countries may not affect them as severely as it would in a lesser developed country.

How to Tackle Current Account Deficits

There are a number of ways in which nations take care of the imbalance in their accounts depending upon the situation and the cause of the deficits. Some of the measures that are/can be adopted are:

Devaluation of the currency. This will cause an automatic rise in the prize of foreign goods thereby reducing demand for imported products and services.
Giving impetus to export of goods and services.
Capitalizing on monopoly goods that can be exported all over the world.
Reducing import of non-essential goods.
Imposing the policy of Protectionism. However, this is only feasible if there is no threat of retaliation from other countries.
Giving impetus to domestic industry via loans, subsidies and vocational education.
When currency value falls, the country’s exports become favourably priced abroad, thereby creating demand. This will help the country reduce its account deficits.
Economists and analysts can predict future trends both in the national and international economies. This is why, when a country receives funds from abroad, they must use it in such a manner that it will help them in the long run, e.g., building infrastructure, laying factories and such.
Countries already facing or expecting deficits should try to create an account surplus as soon as possible to restore balance.

Current Account Deficit for India

During the first 3 quarters of 2020, India experienced a Current Account Surplus. However, in the last quarter of the year, the account fell to a deficit of $1.7 billion (0.2 per cent of Gross Domestic Product (GDP). For the first quarter of the year 2021, India is running at a 1% (of the Gross Domestic Product) deficit according to the Reserve Bank of India. India’s CAD stood at $8.1 billion for the January-March quarter.