Current Account Deficit Meaning
Current Account Deficit 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, a it is a result of high spending on imports compared to income from exports.
Current Account Deficit Formula
Current Account Deficit formula is represented as below,
- X = Value of Exports
- M = Value of Imports
- I = Income from foreign sources
- E =Expenses on foreign sources
- NT = Net transfers by government
Elements of Current Account Deficit
#1 – Trade Deficit
Goods and services which country trade with other countries is the largest component in every economy, therefore if the country has a high level of imports compare to its Exports value resulting in the 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..
#2 – Net Income
There are two sources of income received by people in a country. I.e.
- Income from foreign assets owned by countries’ residents and businesses, known as interest and dividends from overseas investments.
- Income received by people of a country who work in foreign countries.
- Same applicable for Expenses of the country in case of interest and dividend paymentDividend PaymentDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity. on foreign investments and spending on outsourcing of jobs.
- If Income paid is high than income received by countries residents, businesses and government then net income goes in negative.
#3 – Direct Transfers
Country residents who work outside send part of their income to the home country, as well as foreign aid spent or received by the county and Foreign Direct Investment in the country’s business and industries, reflects in the Current account deficit.
#4 – Income from Assets
Increase or decrease in government and central bank reservesBank ReservesBank reserve is the minimum fund limit the commercial banks and other financial institutions have to maintain as per the central bank's guidelines. Each bank preserves such funds either with the large banks or Federal Reserve Bank facility; or in a vault on-site., real estates, bank deposits. Assets owned by foreign individuals and business are subtracted from this income includes
- Deposits in banks of the country from foreign individuals, business.
- The loan provided to domestic banks from foreign banks.
- Investments in Government securities from foreign individuals.
- Security sold to foreigners from domestic businesses.
Below is the example to calculate Current Account Deficit
Therefore, the Current Account Deficit at the US $ 155 Bn.
Effects of Current Account Deficit on Country
- Up to a certain limit, the Current account deficit is not considered as dangerous but in fact helpful since it helps countries’ economies in growth in business and infrastructure.
- In the long run, it may affect the country negatively in terms of economic growth since many businesses operating in-country prefer to outsource jobs because of cheaper labor available in other countries compare to domestic countries. E.g. U.S. companies outsource jobs for their various backend process.
- Reduction in domestic currency value and reduce confidence in assets of countries, which reduces demands in terms of business as well.
- Affect the standard of living of residents.
- Reduction of public expenditure.
- The overall effect on the country and the world economy.
#1 – Greek Debt Crisis
- The huge amount of debts through sovereign bonds owned by Greece from the European Union.
- Greece indicated default on these bonds, which might affect all countries’ economies in the European Union.
- Debt payments for the last 10 years of investments will continue over a period of 40 years. Greece has to take many measurements to reduce deficit percentage to its GDP.
- Measurements resulted in a reduction in pension payments, cut in terms of spend and increase in taxes, the economy decreased by 25% and a rise in unemployment and social instability within the country.
- Various austerity measures resulted in a reduction in public expenditure in Greece and tourism industries resulted in further reduction of income.
- It is expected that over a period economy will get better, Greece will be able to payout its debt because of the increase in the period, and various packages provided by the European Union.
- In 2018, the bailout program closed and until the debt is repaid Creditors from the European Union will continue to supervise austerity measures by Greece government.
- Greece Continued to be part of the European Union to avoid hyperinflationHyperinflationHyperinflation is an accelerated level of inflation that tends to quickly destroy the actual value of the local currency since there is a rise in the cost of all products and services. It forces people to lower their holdings in that particular currency to participate in stable foreign currencies., devaluation of currency because of foreign debts and less credibility.
#2 – Measurements
- Increase in Exports Value: Compare to import country can create new products and services to increase exports or modifications in export prices to manage the level of income from exports.
- Restriction on Imports: Tariffs, Quotas can be implied on products imported in-country to limit imports.
- Policies in favor of Exports: The government can provide benefits to business and industry for an increase in exports like tax benefits, one window for documentation and process.
- Currency Valuation: in case of major changes in policy, government to reduce export cost, Currency Devaluation might be one of the last options.
Current Account deficit although it implies a country’s income less than its spending, is not necessary a disadvantageous for the country since many developing countries need continuous investment and resources in infrastructure, business, and industries for growth, which eventually generates income and employment opportunity to residents over a period. In case a continuous rise in negative current account balance compare to the country’s economy, the government needs to take immediate measures before the situation goes out of control affecting social, the financial status of the country and standard of living of residents of the country.
This has been a guide to Current Account Deficit and it’s Meaning. Here we discuss an example of current account deficit, the balance of payments of the country along with its formula, effects, and elements. You can learn more about from the following articles –