Analyzing the Current Account

 Exports imply demand for a local product while imports point to a need for supplies to meet local production requirements. An export is a credit to a local economy while an import is a debit, an import means that the local economy is liable to pay a foreign economy. Therefore a deficit between exports and imports (goods and services combined) - otherwise known as a balance of trade deficit (more imports than exports) - could mean that the country is importing more in order to increase its productivity and eventually churn out more exports. This in turn could ultimately finance and alleviate the deficit.

 A deficit could also stem from a rise in investments from abroad and increased obligations by the local economy to pay investment income  (a debit under income in the current account). Investments from abroad usually have a positive effect on the local economy because, if used wisely, they provide for increased market value and production for that economy in the future. This can allow the local economy eventually to increase exports and, again, reverse its deficit.

 So, a deficit is not necessarily a bad thing for an economy, especially for an economy in the developing stages or under reform: an economy sometimes has to spend money to make money. To run a deficit intentionally, however, an economy must be prepared to finance this deficit through a combination of means that will help reduce external liabilities and increase credits from abroad. For example, a current account deficit that is financed by short-term portfolio investment or borrowing is likely more risky. This is because a sudden failure in an emerging capital market or an unexpected suspension of foreign government assistance, perhaps due to political tensions, will result in an immediate cessation of credit in the current account.

The Bottom Line

 The volume of a country's current account is a good sign of economic activity. By scrutinizing the four components of it, we can get a clear picture of the extent of activity of a country's industries, capital market, services and the money entering the country from other governments  or  through  remittances.  However,  depending  on  the  nation's  stage  of economic growth, its goals, and of course the implementation of its economic program, the state of the current account is relative to the characteristics of the country in question. But when analyzing a current account deficit or surplus, it is vital to know what is fueling the extra credit or debit and what is being done to counter the effects (a surplus financed by a donation may not be the most prudent way to run an economy). On a separate note, the current  account  also  highlights  what  is  traded  with  other  countries,  and  it  is  a  good reflection of each nation's comparative advantage in the global economy.