Asad Umar Federal Finance Minister said that the Current Account Deficit had reached US$ 18 billion and the bailout from someone was vital. He also said, I had told Prime Minister Imran Khan that there was no option except to get the loan from the International Monetary Fund (IMF) due to current account deficit and dollar price in Pakistan. But few questions are in every mind i.e. what is current account? what is current account deficit?. In this article I will explain current account deficit, definition, components and causes.
What Is Current Account?
The current account records a nation’s transactions with the rest of the world – specifically its net trade in goods and services, its net earnings on cross-border investments, and its net transfer payments – over a defined period of time, such as a year or a quarter.
What Is Current Account Deficit:
A current account deficit is when a country imports more goods, services, and capital than it exports. The current account measures trade plus transfers of capital. The Bureau of Economic Analysis count specifies three types. First is international income. Second are direct transfers of capital. The third is investment income made on assets. A current account deficit is created when a country trusts on foreigners for the capital to invest and spend. Depending on why the country is running the deficit, it could be a positive sign of growth. It could also be a negative sign that the country is a credit risk.
Current Account Components:
The first major component of a current account deficit is the trade deficit. That’s when the country imports more goods and services than it exports. The current Pakistan trade deficit shows just how competitive the Pakistan’s economy is in the global market.
The second major component is a deficit in net income. That’s when foreign investment income exceeds the savings of the country’s residents. This foreign investment can help a country’s economy grow. But if foreign investors worry they won’t get a return in a reasonable amount of time, they will cut off funding. That causes widespread panic.
Net income is measured by the following four things.
1. Payments made to foreigners in the form of dividends of domestic stocks.
2. Interest payments on bonds.
3. Wages paid to foreigners working in the country.
4. Direct transfers, mostly money foreign residents send back to their home countries. It also includes government grants to foreigners. This component is the smallest, but the most hotly contested.
Current Account Deficit Causes?
Countries with current account deficits are big payers that foreign investors consider credit worthy. These countries’ businesses can’t borrow from their own residents. They simply haven’t saved enough in local banks. Businesses in a country like this can’t expand unless they borrow from foreigners. That’s where the credit-worthiness comes into the picture. If a country has a lot of spendthrifts, it won’t find any other country to lend to it unless it is very wealthy and looks like it will pay back the loans.
Why would another country lend to such a spender, even if it is credit-worthy? The lender country also exports a lot of goods and even some services to the borrower. The lender country benefits, it can manufacture more goods, thus giving more jobs its people.
How to Reduce Current Account Deficit?
A country can reduce its current account deficit 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 a current account deficit can imply that a country is spending “beyond its means,” having a current account deficit is not inherently detrimental. If a country uses external debt to finance investments that have higher returns than the interest rate on the debt, it can remain solvent while running a current account deficit. If a country is improbable to cover current debt levels with future revenue streams, however, it may become insolvent.