A surplus in a nation’s current account could help to strengthen its currency in the foreign exchange market.
What Is the Current Account?
A nation’s current account represents the broadest measure of trade in its goods and services. It includes the value of exports less the value of imports in addition to any income, transfers, and payments from abroad over a particular period.
Note: In financial terms, a current account refers to a person’s or commercial entity’s checking account. This article, though, focuses on the economic meaning.
How to Calculate a Country’s Current Account
Current Account = (Exports – Imports) + Net Income + Net Transfers
The formula for the current account is derived from the simple calculation for trade, which is exports minus imports. The current account also includes net income, which is net profit (or net loss) of companies’ earnings from abroad, and net transfers, which is the net figure on payments to loans minus disbursements.
Current Account Formula
Current Account = (Exports – Imports) + Net Income + Net Transfers
What Is a Current Account Balance? How Does a Current Account Turn Into a Surplus or Deficit?
To achieve a balance in the current account, exports minus imports, plus net income, and net transfers must equal zero. Net income and net transfers combined aren’t as large as exports and imports, and consequently, the biggest factor tipping the current account into either a surplus or deficit is trade. More exports than imports can push the current account into a surplus, and more imports than exports can mean a deficit.
How Does the Current Account Affect a Nation’s Foreign Exchange Rate?
A surplus in a country’s current account would indicate higher demand for its goods services, and thus benefit its foreign exchange rate, typically leading to an appreciation in the relative value of its currency. A deficit, on the other hand, would show that the country is importing more goods than it exports, and that would mean selling more of its currency to buy the currency of the country where the purchase of goods is made—leading to depreciation.
Currencies of developing nations tend to be more influenced by surpluses or deficits in their current accounts. Surpluses over a period of months or years could lift a country’s foreign exchange reserves, while deficits could exert downward pressure (or depreciation) on its currency.
The U.S. is an exception, in that deficits don’t necessarily affect the foreign exchange rate adversely. For decades, the U.S. has been running a current account deficit because of its huge trade imbalance with China. Yet, the U.S. dollar remains strong relative to major currencies and is the preferred currency of trade.
How Does the Current Account Affect a Nation’s Economy?
Generally, a current account surplus is favorable for a country’s economy. It demonstrates that demand for its goods is positive, and high demand for a country’s exports tends to strengthen its economy. More money circulating into the economy typically helps to raise people’s incomes. However, a prolonged period of surpluses could lead to a pick-up in inflation, leading to the country’s central bank tightening monetary policy and raising interest rates.
How Does Current Account Differ From Capital Account?
A country’s capital account, in economic terms, records transactions between businesses and people within its own borders and those from abroad. Assets can include land ownership, government permits for mineral exploration, and intellectual property.
A nation’s current account and capital account, along with other types of accounts, make up its balance of payments, which is a measure of summarized transactions between itself and other countries.
