A current account deficit (CAD) allows residents to consume more products that it produces. However the country needs to finance the deficit by attracting investment into the country or by borrowing. This will involve an outlow of money in the future in the form of investment income. An increase in a CAD may also reduce AD, which may slow down economic growth and may cause unemployment.
A CAD could be indicative of a lack of competitiveness but it could also mean an excess of investment over savings which could mean a highly productive, growing economy. Although there is a deficit an important question is what the deficit is made up of? If a country is importing a significant amount of capital goods then these can add value to the economy by creating jobs and growth. For example if Air New Zealand buy planes from Airbus these are part of the service that they offer which employs people and generates income. But if a CAD reflects low savings rather than investment, it could be caused by an irresponsible expansionary fiscal/monetary policy like we have seen in New Zealand post-covid.
New Zealand’s annual current account deficit was $27.8 billion for the year ended in the June 2022 quarter, equivalent to 7.7 percent of GDP. The annual current account deficit rose by $16.3 billion during the year, driven by increases in the goods and services deficits. Sea transport costs (which is a services import cost) rose by $2.2 billion during the year, and was a driver behind a $5.0 billion deterioration in New Zealand’s services balance. However the record-breaking deficit shows we’ve been living beyond our means, becoming more dependent on foreign capital in the process. However CAD reflect underlying economic trends, which may be desirable or undesirable for a country at a particular point in time.
Causes of CAD
- Overvalued exchange rate – If the currency is overvalued, imports will be cheaper, and therefore there will be a higher quantity of imports. Exports will become uncompetitive, and therefore there will be a fall in the quantity of exports.
- Economic growth – If there is an increase in national income, people will tend to have more disposable income to consume goods. If domestic producers cannot meet the domestic demand, consumers will have to import goods from abroad. In New Zealand there is a high tendency to import manufactured goods as we don’t have a comparative advantage.
- Drop in demand from trading partners – If there is a downturn in country A that normally buys another country B’s exports this will mean a loss of export revenue for country B. A current account deficit that results from the economic cycle is referred to as a cyclical deficit. Usually short-term and self-correcting
- Growing domestic economy – when demand increases in the domestic economy it may mean that companies now have to import more capital goods and raw materials from overseas. As well as imports increasing, producers may switch their sales to the domestic market and not overseas (exports). However in the long-term firms output might increase so that they can sell both at home and abroad.
- Higher inflation – if New Zealand’s inflation rises faster than our main competitors then it will make New Zealand exports less competitive and imports more competitive. This will lead to deterioration in the current account. However, inflation may also lead to a depreciation in the currency to offset this decline in competitiveness.
- Structural problems – a current account deficit that is persistent is concerning as it indicates that domestic firms are not internationally competitive and the country may have to borrow from overseas to fund the current account deficit. As well as an overvalued exchange rate (see above) the country might have low labour and capital productivity so finds it hard to compete internationally.
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