The current account balance is one of two major measures of the nature of a country's foreign trade (the other being the net capital outflow). A current account surplus increases a country's net foreign assets by the corresponding amount, and a current account deficit does the reverse. Both government and private payments are included in the calculation. It is called the current account because goods and services are generally consumed in the current period.
The balance of trade is the difference between a nation's exports of goods and services and its imports of goods and services, if all financial transfers, investments and other components are ignored. A Nation is said to have a trade deficit if it is importing more than it exports.
Positive net sales abroad generally contributes to a current account surplus; negative net sales abroad generally contributes to a current account deficit. Because exports generate positive net sales, and because the trade balance is typically the largest component of the current account, a current account surplus is usually associated with positive net exports. This however is not always the case with secluded economies such as that of Australia featuring an income deficit larger than its trade deficit.
The net factor income or income account, a sub-account of the current account, is usually presented under the headings income payments as outflows, and income receipts as inflows. Income refers not only to the money received from investments made abroad (note: investments are recorded in the capital account but income from investments is recorded in the current account) but also to the money sent by individuals working abroad, known as remittances, to their families back home. If the income account is negative, the country is paying more than it is taking in interest, dividends, etc.
The difference between Canada's income payments and receipts have been declining exponentially as well since its central bank in 1998 began its strict policy not to intervene in the Canadian Dollar's foreign exchange.
The various subcategories in the income account are linked to specific respective subcategories in the capital account, as income is often composed of factor payments from the ownership of capital (assets) or the negative capital (debts) abroad. From the capital account, economists and central banks determine implied rates of return on the different types of capital. The United States, for example, gleans a substantially larger rate of return from foreign capital than foreigners do from owning United States capital.
Reducing current account deficits
Action to reduce a substantial current account deficit usually involves increasing exports (goods going out of a country and entering abroad countries) or decreasing imports (goods coming from a foreign country into a country).Firstly,This is generally accomplished directly through import restrictions, quotas, or duties (though these may indirectly limit exports as well), or subsidizing exports. Influencing the exchange rate to make exports cheaper for foreign buyers will indirectly increase the balance of payments. This is primarily accomplished by devaluing the domestic currency example: The chinese goverenment policy of pegging renminbi to dollar to ensure competitive export policy.Also,Currency Wars,a phenomenon evident in post recessionary markets is a protectionist policy,whereby countries devalue their currencies to ensure export competitiveness.Secondly,current account deficit are reduced by promoting investor friendly environment i.e. Foreign Direct Investment(FDI),Foreign Institutional Investors(FII),the income from these foreign investments positively contributes to current account.Thirdly,Adjusting government spending to favor domestic suppliers is also effective.Less obvious methods to reduce a current account deficit include measures that increase domestic savings (or reduced domestic borrowing), including a reduction in borrowing by the national government.
The Pitchford thesis
A current account deficit is not always a problem. The Pitchford Thesis states that a current account deficit does not matter if it is driven by the private sector. Some feel that this theory has held true for the Australian economy, which has had a persistent current account deficit, yet has experienced economic growth for the past 18 years (1991-2009). This has been attributed to persistent drawing on foreign investment (Around 60% in the form of debt securities) generating a significant income deficit. Others argue that Australia is accumulating a substantial foreign debt that could become problematic, especially if interest rates increase. A deficit in the current account also implies that the country is a net capital importer, foreign aid is a part of current account.Interrelationships in the balance of payments
Main article: Balance of payments
Absent changes in official reserves, the current account is the mirror image of the sum of the capital and financial accounts. One might then ask: Is the current account driven by the capital and financial accounts or is it vice versa? The traditional response is that the current account is the main causal factor, with capital and financial accounts simply reflecting financing of a deficit or investment of funds arising as a result of a surplus. However, more recently some observers have suggested that the opposite causal relationship may be important in some cases. In particular, it has controversially been suggested that the United States current account deficit is driven by the desire of international investors to acquire U.S. assets (See Ben Bernanke, William Poole links below [which ones exactly? missing reference number/link]). However, the main viewpoint undoubtedly remains that the causative factor is the current account and that the positive financial account reflects the need to finance the country's current account deficit.