Intro: While a current account surplus is preferable to a current account deficit all else equal, little information can be gleaned from the current account alone. The important point to note is the country’s savings rate.
As explained previously in ‘The Current Account Reflects the Saving-Investment Relationship’ a current account surplus reflects either a low investment rate relative to GDP or a high savings rate, or a combination of the two. Likewise, a country with a current account deficit means it either has a low savings rate or a high investment rate.
What this means is that a current account deficit itself is not necessarily a good or a bad thing. High levels of investment (assuming that it is profitable and not malinvestment) are of course beneficial for economic growth, and savings are required for that investment to take place. However, a current account surplus of, say 5% of GDP, may be the result of a low rate of saving, but an even lower rate of investment, which does not paint a particularly strong picture of the economy.
Let’s look at two examples in India and Taiwan. The former runs a current account deficit while the latter runs a surplus. However, India’s savings rate is actually considerably higher, and indeed the current account weekness in the former and strength in the latter is entirely down to relative investment strength and weakness. The key point to note is that it is savings that matter for economic strength. Ideally, India would raise its savings rate to allow domestic investment to be funded domestically rather than from overseas borrowing.
It is usual for cyclical economic weakness to result in an ‘improvement’ in the current account balance. The reason is that when economies experience downturns, investment tends to weaken faster than overall output as companies continue to pay wages and demand for essential consumer goods remains relatively high. As a result, imports tend to fall faster than exports and the current account deficit narrows or surplus rises. Simultaneously, foreign investors may withdraw their investments from the country, putting downside pressure on the currency, and further reducing imports and supporting exports, to the benefit of the current account.
