What Is a Current Account Deficit?
The current account deficit is a measurement of a country’s trade where the value of the goods and services it imports exceeds the value of the products it exports. The current account includes net income, such as interest and dividends, and transfers, such as foreign aid, although these components make up only a small percentage of the total current account. The current account represents a country’s foreign transactions and, like the capital account, is a component of a country’s balance of payments (BOP).
Current Account Deficit
- A current account deficit indicates that a country is importing more than it is exporting.
- Emerging economies often run surpluses, and developed countries tend to run deficits.
- A current account deficit is not always detrimental to a nation's economy—external debt may be used to finance lucrative investments.
Understanding a Current Account Deficit
A country can reduce its existing debt by increasing the value of its exports relative to the value of imports. It can place restrictions on imports, such as tariffs or quotas, or it can emphasize policies that promote export, such as import substitution, industrialization, or policies that improve domestic companies' global competitiveness. The country can also use monetary policy to improve the domestic currency’s valuation relative to other currencies through devaluation, which reduces the country’s export costs.
While an existing deficit can imply that a country is spending beyond its means, having a current account deficit is not inherently disadvantageous. If a country uses external debt to finance investments that have higher returns than the interest rate on the debt, the country can remain solvent while running a current account deficit. If a country is unlikely to cover current debt levels with future revenue streams, however, it may become insolvent.
Deficits in Developed and Emerging Economies
A 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. Impoverished countries tend to run current account debt.
Real World Example of Current Account Deficits
Fluctuations in a country's current account are largely dependent on market forces. Even countries that purposefully run deficits have volatility in the deficit. The United Kingdom, for example, saw a decrease in its existing deficit after the Brexit vote results in 2016.
The United Kingdom has traditionally run a deficit because it is a country that uses high levels of debt to finance excessive imports. A large portion of the country's exports are commodities, and declining commodity prices have resulted in lower earnings for domestic companies. This reduction translates to less income flowing back into the United Kingdom, increasing its current account deficit.
However, after the British pound declined in value as a result of the Brexit vote that was held on June 23, 2016, the weaker pound decreased the nation's existing debt. This decrease occurred because overseas dollar earnings were higher for domestic commodity companies, resulting in more cash inflows to the country.