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Current Account Deficit

Updated on January 25, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Current Account Deficit Meaning

A current account deficit (CAD) arises when a nation’s total import value is more than its total export value. It signifies that an economy buys more from other nations, making its spending exceed the income it generates from selling its products and services to the rest of the countries. Thus, this deficit occurs when a nation’s expenditure is more than its income.

current account deficit

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Current Account Deficit marks the disbalance in a nation’s economy, which indicates more expenditure on imports and less income through exports. This disbalance increases the chances of credit risks as the struggling nations start depending on and expecting their foreign counterparts to invest and offer funds to bring the economic balance back.

Key Takeaways

  • Current Account Deficit marks the economic phenomenon where a nation’s total value of imports is more than its total value of exports.
  • A current account keeps track of the flow of products and services to and from a country.
  • The deficit can have both good and bad effects.
  • While the current account deficit concerns expense and income perspectives, the trade deficit concept revolves around the volume of goods exported and imported.

Current Account Deficit Explained

The current account deficit concept signifies the current account’s funds shortage. A current account keeps track of the flow of products and services to and from a country. Thus, whenever the value of the items imported becomes more than that of the commodities exported, the account is said to be slipping into a deficit state. 

The current account records everything from net income to net liabilities, including foreign aidForeign AidForeign aid or international aid refers to the voluntary transfer of resources like money, goods like food, drugs, weapons, or technical services, and training from a developed country to a developing one in the form of a loan. Governments or international or non-governmental organizations provide it to address issues like terrorism, environmental degradation, pandemics, etc.read more. As far as the current account of an economy or country is concerned, it monitors the trade of goods and services and records the net earnings on foreign investment and net payment transfers over a period, also known as remittances.

When a country imports goods, it pays the other nation in exchange for the items received. Hence, it becomes an expenditure for the former. On the other hand, exporting goods to other economies helps a country reap profits, which become its income. However, when the expense exceeds the income, it leads to deficits.

CAD is identified as the economy’s incompetency. As a result, investors are less willing to invest in anything related to that nation. Thus, the nations must work and ensure that the value of imports does not go beyond the value of exports in the country.

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Causes

The deficit is caused by the disbalance between the import and export values, and some reasons lead to this difference. Some of them have been elaborated on below:

current account deficit causes

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When the currency value of a country is high, imports are cheaper. As the domestic currency value is higher, importing products is inexpensive, so the nations prefer buying from the other economies. Plus, they go for fewer exports as they know the prices of the imported products would be lower than what they spend in producing the items in-house.

When the economic growth is significant, it indicates higher national income. As a result, consumers can spend more. In such a situation, if the domestic products do not satisfy their requirements, they would demand goods from overseas. This, in turn, leads to increased imports, causing the difference between export value and import value to increase. For example, the current account deficit in the UK is quite significant, given the improving economic growth. In 2022, it is expected to reach 4% of GDP from 2.6% in 2021.

If inflation rises frequently, the costs of goods and products rise. As a result, people refrain from buying them from their own nation. Instead, they order from other economies. Thus, the imports increase and exports decrease. 

Another one is the deteriorating dominance of the export sector. When a country’s manufacturing sector cannot beat the developing nations, it disturbs the balance of trade, causing current accounts to run into deficit.

Effects

The consequences of the situation are both good and bad. Here is a list of the effects of such an economic phenomenon:

  • A lenient deficit figure helps the borrowing nations in retaining their economic stability. It is one of the advantages of the deficit caused to the current account.
  • It helps the domestic economy to build business and infrastructure.
  • If the same situation continues in an economy, it impacts it negatively. The organizations in the United States prefer outsourcing jobs in exchange for cheaper wages and salaries, making it one of the main reasons behind the current account deficit in the US.
  • The decreasing exports and increasing imports lead to the reduction in domestic currency value and loss of confidence in domestic assets. As a result, the products witness lack of demand.
  • It affects the standard of living of residents. It reduces the expenditure from the public, thereby hampering the global economy, which becomes one of the most worrying disadvantages of CAD.

Examples

Let us consider the following examples for a better understanding of the concept:

Example 1

The current account deficit of India was recorded at 1.5% of the GDP for the financial year 2021-22, which is quite an improvement from 2.6% as recorded in the third quarter of the period. The improvement in the economic stability came following the remittances from Indians living overseas and the software exports that rose significantly. Plus, the dividendDividendDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more outflow and interest payouts have dipped considerably.

Example 2

The current account deficit in Pakistan, as recorded in December 2021, was 7.6%, different from that in November, which was recorded at 7.3%. The significant trade shock that emerged amidst the economic recovery process was the reason behind the deficit being $9.09 billion against the surplus of $1.25 billion for the same period in 2020.

Current Account Deficit vs Trade Deficit

CAD and trade deficitTrade DeficitWhen the total sum of goods or services that a country imports from other countries is higher than the total sum of goods or services that a country exports to other countries, this is referred to as a trade deficit, which is the opposite of the balance of trade theory.read more are the terms that determine the measure of imports and exports. Though both the terms are confusing, understanding the concept clears all doubts.

While CAD concerns expense and income perspectives, the trade deficit concept revolves around the volume of goods exported and imported. The former is about the value of the sale and purchases made, while the latter is the number of sales and purchases made.

When the import value is more than the export value, it is the CAD. On the contrary, when the number of imports exceeds the number of exports, it’s the trade deficit.

Frequently Asked Questions (FAQs)

What is the current account deficit in economics?

It is a situation where a country’s total value of products and services imported goes beyond the value of products and services it exports. In general, it results from high spending on imports compared to income from exports.

Is the current account deficit good or bad?

It can be good and bad, depending on the factors causing it. As the figures here indicate that the value of imports is more than the value of export, competitive issues are reflected, showing how bad it can be for an economy. On the other hand, the same deficit indicates increased investment opportunities over savings, reflecting its productive nature, a necessity for the growth of an economy.

How to reduce the current account deficit?

There are ways in which these deficits can be reduced or controlled, or rectified. Some of them include investing in foreign capital to take the economy out of the turmoil, creating a surplus account, and improving the in-house productivity to make the domestic market competitive enough to stand with the dominating global players. In addition, nations with deficits should restrict imports, and domestic markets should be encouraged.

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