Question

Is current account deficit worrisome? Will this affect future economic growth? Why or why not?

Answer 1

1. A current account deficit means the value of imports of goods/services / investment incomes is greater than the value of exports. It is sometimes referred to as a trade deficit. Though a trade deficit (goods) is only part of the current account.

If there is a current account deficit, it means there is a surplus on the financial/capital account.

If a current account deficit is financed through borrowing it is said to be more unsustainable. This is because borrowing is unsustainable in the long term and countries will be burdened with high-interest payments. A very high balance of payments deficit may, at some point, cause a loss of confidence by foreign investors. Therefore, there is always a risk, that investors will remove their investments causing a big fall in the value of your currency (devaluation). This can lead to a decline in living standards and lower confidence for investment.

If you run a current account deficit, it means you need to run a surplus on the financial/capital account. This means foreigners have an increasing claim on your assets, which they could desire to be returned at any time. For example, if you run a current account deficit, it could be financed by foreign multinationals investing in your country or the purchase of assets. There is a risk that your best assets could be bought by foreigners, reducing long-term income.

A persistent current account deficit may imply that you are relying on consumer spending, and the economy is becoming unbalanced between different sectors and between short-term consumption and long-term investment.

2. When a country runs a current account deficit, it is building up liabilities to the rest of the world that are financed by flows in the financial account. Eventually, these need to be paid back. Common sense suggests that if a country fritters away its borrowed foreign funds in spending that yields no long-term productive gains, then its ability to repay its basic solvency might come into question. This is because solvency requires that the country be willing and able to (eventually) generate sufficient current account surpluses to repay what it has borrowed. Therefore, whether a country should run a current account deficit (borrow more) depends on the extent of its foreign liabilities (its external debt) and on whether the borrowing will be financing investment that has a higher marginal product than the interest rate (or rate of return) the country has to pay on its foreign liabilities. The current account deficit ma not necessarily affect the economic growth if there are adequate measures to curb and reduce it