3/28/2016 BacktoBasicsDoCurrentAccountDeficitsMatter?

Finance&DevelopmentDecember2006

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AquarterlymagazineoftheIMF December2006,Volume43,Number4

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DoCurrentAccountDeficitsMatter?
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AdvancedSearch AtishGhoshandUmaRamakrishnan
AboutF&D
THECURRENTaccountbalancemayseemtobeanabstruse
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economicconcept.Butincountriesthatarespendingalotmore
BackIssues abroadthantheyaretakingin,thecurrentaccountisthepointat
WriteUs whichinternationaleconomicscollideswithpoliticalreality.When
countriesrunlargedeficits,businesses,tradeunions,and
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parliamentariansareoftenquicktopointaccusingfingersattrading
partnersandmakechargesaboutunfairpractices.Tensionbetween
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theUnitedStatesandChinaaboutwhichcountryisprimarily
Notification responsibleforthetradeimbalancebetweenthetwohasthrownthe
spotlightonthebroaderconsequencesfortheinternationalfinancial
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whenwepostnew systemwhensomecountriesrunlargeandpersistentcurrentaccount
itemsofinterestto deficitsandothersaccumulatebigsurpluses.
you.
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Modifyyourprofile TheIMF,whosemandateincludespromotingandmaintainingan
openinternationaltradeandpaymentssystem,hasrecentlystarted
multilateralconsultationsonglobalimbalanceswiththemajor
players:China,theeuroarea,Japan,SaudiArabia,andtheUnited
States.BacktoBasicstriestoremovetheemotionfromtheissueand
examinewhethercurrentaccountsurplusesanddeficitsevenmatter.

Measuringthecurrentaccount

Agoodstartingpointistoaskwhatacurrentaccountdeficitor
surplusreallymeansandtodrawinsightsfromthemanywaysthata
currentaccountbalanceismeasured.First,itcanbeexpressedasthe
differencebetweenthevalueofexportsofgoodsandservicesand
thevalueofimportsofgoodsandservices.Adeficitthenmeansthat
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3/28/2016 BacktoBasicsDoCurrentAccountDeficitsMatter?Finance&DevelopmentDecember2006

thecountryisimportingmoregoodsandservicesthanitisexporting
althoughthecurrentaccountalsoincludesnetincome(suchas
interestanddividends)andtransfersfromabroad(suchasforeign
aid),whichareusuallyasmallfractionofthetotal.Expressedthis
way,acurrentaccountdeficitoftenraisesthehacklesof
protectionists,whoapparentlyforgettingthatamainreasonto
exportistobeabletoimportthinkthatexportsare"good"and
importsare"bad."

Second,thecurrentaccountcanbeexpressedasthedifference
betweennational(bothpublicandprivate)savingsandinvestment.
Acurrentaccountdeficitmaythereforereflectalowlevelofnational
savingsrelativetoinvestmentorahighrateofinvestmentorboth.
Forcapitalpoordevelopingcountries,whichhavemoreinvestment
opportunitiesthantheycanaffordtoundertakewithlowlevelsof
domesticsavings,acurrentaccountdeficitmaybenatural.Adeficit
potentiallyspursfasteroutputgrowthandeconomicdevelopment
althoughrecentresearchdoesnotindicatethatdevelopingcountries
thatruncurrentaccountdeficitsgrowfaster(perhapsbecausetheir
lessdevelopeddomesticfinancialsystemscannotallocateforeign
capitalefficiently).Moreover,inpractice,privatecapitaloftenflows
fromdevelopingtoadvancedeconomies.Theadvancedeconomies,
suchastheUnitedStates,runcurrentaccountdeficits(seechart),
whereasdevelopingcountriesandemergingmarketeconomiesoften
runsurplusesornearsurpluses.Verypoorcountriestypicallyrun
largecurrentaccountdeficits,inproportiontotheirGDP,thatare
financedbyofficialgrantsandloans.

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Onepointthatthesavingsinvestmentbalanceapproachunderscores
isthatprotectionistpoliciesareunlikelytobeofmuchusein
improvingthecurrentaccountbalancebecausethereisnoobvious
connectionbetweenprotectionismandsavingsorinvestment.

Third,thecurrentaccountcanbeviewedintermsofthetimingof
trade.Weareusedtointratemporaltradeexchangingclothforwine
today.Butwecanalsothinkofintertemporaltradeimportinggoods
today(runningacurrentaccountdeficit)and,inreturn,exporting
goodsinthefuture(runningacurrentaccountsurplusthen).Justasa
countrymayimportonegoodandexportanotherunderintratemporal
trade,thereisnoreasonwhyacountryshouldnotimportgoodsof
todayandexportgoodsoftomorrow.

Intertemporaltheoriesofthecurrentaccountalsostressthe
consumptionsmoothingrolethatcurrentaccountdeficitsand
surplusescanplay.Forinstance,ifacountryisstruckbyashock
perhapsanaturaldisasterthattemporarilydepressesitsabilityto
accessproductivecapacity,thenratherthantakethefullbruntofthe
shockimmediately,itcanspreadoutthepainovertimebyrunninga
currentaccountdeficit.Conversely,researchalsosuggeststhat
countriesthataresubjecttolargeshocksshould,onaverage,run
currentaccountsurplusesasaformofprecautionarysavings.

Whenpersistentistoopersistent

Doesitmatterhowlongacountryrunsacurrentaccountdeficit?
Whenacountryrunsacurrentaccountdeficit,itisbuildingup
liabilitiestotherestoftheworldthatarefinancedbyflowsinthe
financialaccount.Eventually,theseneedtobepaidback.Common
sensesuggeststhatifacountryfrittersawayitsborrowedforeign
fundsinspendingthatyieldsnolongtermproductivegains,thenits
abilitytorepayitsbasicsolvencymightcomeintoquestion.This
isbecausesolvencyrequiresthatthecountrybewillingandableto
(eventually)generatesufficientcurrentaccountsurplusestorepay
whatithasborrowed.Therefore,whetheracountryshouldruna
currentaccountdeficit(borrowmore)dependsontheextentofits
foreignliabilities(itsexternaldebt)andonwhethertheborrowing
willbefinancinginvestmentthathasahighermarginalproductthan
theinterestrate(orrateofreturn)thecountryhastopayonitsforeign
liabilities.

Butevenifthecountryisintertemporallysolventmeaningthat
currentliabilitieswillbecoveredbyfuturerevenuesitscurrent
accountdeficitmaybecomeunsustainableifitisunabletosecurethe
necessaryfinancing.Whilesomecountries(suchasAustraliaand
NewZealand)havebeenabletomaintaincurrentaccountdeficits
averagingabout4to5percentofGDPforseveraldecades,others
(suchasMexicoin1995andThailandin1997)experiencedsharp
reversalsoftheircurrentaccountdeficitsafterprivatefinancing
withdrewinthemidstoffinancialcrises.Suchreversalscanbehighly
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disruptivebecauseprivateconsumption,investment,andgovernment
expendituremustbecurtailedabruptlywhenforeignfinancingisno
longeravailableand,indeed,acountryisforcedtorunlargesurpluses
torepayinshortorderitspastborrowings.Thissuggeststhat
regardlessofwhythecountryhasacurrentaccountdeficit(andeven
ifthedeficitreflectsdesirableunderlyingtrends)cautionisrequired
inrunninglargeandpersistentdeficits,lestthecountryexperiencean
abruptandpainfulreversaloffinancing.

Whatdetermineswhetheracountryexperiencessuchareversal?
Empiricalresearchsuggeststhatanovervaluedrealexchangerate,
inadequateforeignexchangereserves,excessivelyfastdomestic
creditgrowth,unfavorabletermsoftradeshocks,lowgrowthin
partnercountries,andhigherinterestratesinindustrialcountries
influencetheoccurrenceofreversals.Morerecentliteraturehasalso
focusedontheimportanceofbalancesheetvulnerabilitiesintherun
uptoacrisis,suchastheextentofliabilitydollarizationandmaturity
mismatches.Ithasalsounderscoredtheimportanceofthe
compositionofcapitalinflowsforexample,therelativestabilityof
foreigndirectinvestmentversusportfolioandothertypesofshort
terminvestmentflows.Moreover,weakfinancialsectorsoftenleadto
highervulnerabilitytoareversalasbanksborrowmoneyfromabroad
andmakeriskydomesticloans.Conversely,aflexibleexchangerate
regime,higherdegreeofopenness,exportdiversification,financial
sectordevelopment,andcoherentfiscalandmonetarypoliciesare
somefactorsthatmakeacountrywithpersistentdeficitsless
vulnerabletoareversal.

So,aredeficitsbad?

Acommoncomplaintabouteconomicsisthattheanswertoany
questionis,"Italldepends."Itistruethateconomictheorytellsus
thatwhetheradeficitisgoodorbaddependsonthefactorsgiving
risetothatdeficit,buteconomictheoryalsotellsuswhattolookfor
inassessingthedesirabilityofadeficit.

Ifthedeficitreflectsanexcessofimportsoverexports,itmaybe
indicativeofcompetitivenessproblems,butbecausethecurrent
accountdeficitalsoimpliesanexcessofinvestmentoversavings,it
couldequallybepointingtoahighlyproductive,growingeconomy.If
thedeficitreflectslowsavingsratherthanhighinvestment,itcould
becausedbyrecklessfiscalpolicyoraconsumptionbinge.Orit
couldreflectperfectlysensibleintertemporaltrade,perhapsbecause
ofatemporaryshockorshiftingdemographics.Withoutknowing
whichoftheseisatplay,itmakeslittlesensetotalkofadeficitbeing
"good"or"bad":deficitsreflectunderlyingeconomictrends,which
maybedesirableorundesirableforacountryataparticularpointin
time.

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3/28/2016 BacktoBasicsDoCurrentAccountDeficitsMatter?Finance&DevelopmentDecember2006

AtishGhoshisaDivisionChiefandUmaRamakrishnanisaSeniorEconomist
intheIMF'sPolicyDevelopmentandReviewDepartment.

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