Corporate Finance & Accounting

current account deficit

What is a current account deficit?

The current account deficit is a measure of a country’s trade in goods and services that exceed the value of its exports. The current account includes net income such as interest and dividends, as well as transfers such as foreign aid, although these components represent only a small portion of the total current account. The current account represents a country’s external transactions and, like the capital account, is a component of a country’s balance of payments (BOP).

key takeaways

  • A current account deficit indicates that a country imports more than it exports.
  • Emerging economies often run surpluses, while developed countries tend to run deficits.
  • A current account deficit isn’t always bad for a country’s economy — foreign debt can be used to fund profitable investments.

Understanding the current account deficit

A country can reduce its existing debt by increasing the value of its exports relative to the value of its imports. It can impose restrictions on imports, such as tariffs or quotas, or it can emphasize policies that promote exports, such as import substitution, industrialization, or policies that increase the global competitiveness of domestic firms. The country can also use monetary policy to increase the valuation of its currency relative to other currencies by devaluing it, thereby reducing the cost of the country’s exports.

While an existing deficit can mean that a country is spending more than it can afford, a current account deficit is not an inherent disadvantage. If a country uses external debt to finance investments with higher returns than debt interest rates, the country can remain solvent while running a current account deficit. However, if a country is unlikely to cover current levels of debt with future income streams, it could go bankrupt.

Deficits in advanced and emerging economies

The current account deficit represents negative net sales abroad. Developed countries such as the United States often run deficits, while emerging economies often run current account surpluses. Poor countries tend to take on current account debt.

Real examples of current account deficits

Volatility in a country’s current account is largely determined by market forces. Even countries that are deliberately running deficits experience deficit volatility. For example, after the 2016 Brexit referendum result, the UK’s existing deficit was reduced.

Britain has traditionally run a deficit because it is a country that uses high debt to finance excessive imports. A large portion of the country’s exports are commodities, and falling commodity prices have led to lower earnings for domestic companies. This reduction means less income is flowing back to the UK, thereby increasing its current account deficit.

However, after the Brexit referendum on June 23, 2016, which led to the devaluation of the pound, the devaluation of the pound reduced the country’s existing debt. The decline was due to higher overseas dollar earnings from domestic commodity companies, leading to higher cash flows into the country.

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