Question

In: Finance

Consider a situation where Kuwait has a current account deficit. What can you conclude about Kuwait’s...

  1. Consider a situation where Kuwait has a current account deficit.
    1. What can you conclude about Kuwait’s levels of domestic savings, domestic investment, international capital flows, and their capital account?
    2. Assuming that Kuwait has a floating exchange rate and perfect capital mobility, how would a decrease in the level of Kuwaiti savings impact their balance of payments?

Solutions

Expert Solution

a) Current account deficit occurs when the imports are greater than the exports however it can be affected by two other factors like net income from abroad and net current transfer received from abroad. So current account balance formula equals

Current account balance = Exports – imports + Net income received from abroad + Net current transfer received from abroad

When there is a trade deficit that means domestic savings and investment will be negatively affected. The capital flow from international has to be positive for the capital account to balance however consistently running large deficit can shake the trust of the investors and the international investors might see the country as high risky.

b) A fall in the level of domestic saving means that people are spending more so domestic investment will also fall and the deficit in the balance of payment has to be met by borrowing from the international investors, this will in turn put pressure on the currency demand and then again it will make the country less attractive for exporting of goods and services.


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