What is the Current Account Deficit?
Current Account Deficit is the measures the flow of good services and investment into and out of the country. We run into a deficit if the value of goods and services we import exceeds the value of those we export.
Now before understanding it in detail let’s understand what are the current account transactions?
What is Current Account Transaction?
- Current account transactions are the transaction which requires foreign currency to execute. For example, payments connected with foreign trade that is import and export which is the biggest component of the current account.
- Interest on loans given to other countries or taken from other countries is also part of current account transactions.
- Net income from investment in other countries remittances for living expenses of parents, spouse, children and residing abroad also comes under current account transactions as it involves foreign currency.
- Expenses in connection with foreign travel, foreign education and medical care of parents, spouse, and children come under current account transaction.
How the Current Account Deficit is Calculated?
Total Value of Goods and Services coming into the country
|Total Value||$1450 million|
|Expenses in connection with Foreign travel, health, education etc.||$200 million|
|Interest and Dividends paid to other countries||$150 million|
|Other Outflow||$100 million|
Total Value of Goods and Services going out of the country
|Total Value||$1400 million|
|Income from Foreigners travelling to the country, Education, Health etc.||$150 million|
|Interest and Dividend earned||$200 million|
|Other Inflow||$150 million|
So, in this case, the current result will be the total value of goods and service coming into the country – the total value of goods and services going out of the country.
Current Account Deficit = $1450 million – $1400 = $50 million.
So we can say that the current account deficit occurs when the value of goods and services coming into the country exceeds the value of goods and services going out of the country.
Now we will understand the difference between the CAD and the Trade Deficit.
What is a Trade Deficit?
The trade deficit is an economic measure of a negative of trade image in which countries imports exceeds its exports. A trade deficit represents an outflow of domestic currency to foreign markets. The trade deficit actually is a subset of current account deficit. Trade deficit only measures the difference in exports and imports and doesn’t consider other transfer or interest or dividends.
How Current Account Deficit is Financed?
It can be financed by capital account or financial account. Now government buys and sells foreign currency. So may give the loan to other countries or may take a small short-term loan from other countries. That may change the value of the current account and this type of financing is done.
Another more popular and more important way of financing the current account deficit is through capital account transaction. Now below are the major types of transactions.
- FDI: This is the best way to fund current account deficit. As this is a long-term money which comes into the country.
- Foreign Indirect Investment: In the equity markets or debt markets of a country and these are called hot money and they can go out of the country very quickly. So, therefore, it cannot be dependent on for long term.
- Remittances: Which comes as investment India. Investment can be in real estate or in other financial assets.
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