The Current Account Deficit

Issue 1: The Current Account Deficit

The current account balance is defined as the sum of exports of goods and services minus imports of goods and services. A deficit means that the country accumulates external liabilities as it finances this deficit with foreign credit. Some forms of foreign credit include external debt, foreign direct investment, aid, portfolio investment and more. The current account balance is an indicator of the state of the economy. If investors believe the country’s account balance is unsustainable, they will choose to not hold assets in that country’s economy. In the worst case scenario, it could lead to a currency crisis or an economic downturn. Another downside of current account deficits is the accumulation of foreign debt. In order to continuously keep up their level of imports, countries like Rwanda increase their foreign debt as their exports cannot pay for their level of imports. This debt has to eventually be repaid at some point in time. As such, the government has two choices in order to deal with this debt, they can either raise taxes or in an unsustainable way, raise more debt. Raising taxes will affect decisions by investors with negative consequences for output and employment and raising more debt will increase the intensity of unsustainable current account deficit issues.Another way to view the current account deficit is to look at savings and investment. If savings are less than investment, the economy needs to import resources to finance the investment beyond savings.

Many African countries are currently in a current account deficit and Rwanda is no exception. In 2016, the deficit reached 15.3% of its GDP and the country seems to be in no position to close that deficit any time soon. Using African Economic Conference of 2007 measurements for indicators of unsustainable current account deficit, we can see that Rwanda has 6 out of 7 indicators of an unsustainable deficit. A country can only sustain a deficit for a limited period of time and eventually need to generate a surplus to bring the economy back into balance. As such, there are many concerns about the sustainability of these deficits and rising debt levels needed to sustain them.

In other examples, we can see many countries that have failed to solve their consequences of a current account deficit. For example, in the 1980s, Latin America had a debt crisis where countries like Mexico, Brazil and Argentina had high current account deficits and a resulting high economic downturn. The famous 1997/1998 East Asian Financial crises also showed a pattern of high current account deficit and economic downturn. In 1996, the US deputy secretary of Treasury, Lawrence Summers stated that “close attention should be paid to any current account deficit in excess of 5% of GDP, particularly if it is financed in a way that could lead to rapid reversals”.

Issue 1: Recommendations of Public Policy for Current Account Deficit

Figure X Data from Statista: Rwanda: Gross Domestic Product (GDP) in Current Prices

Figure X: Current Account Balance of Rwanda (% of GDP) from The World Bank

Figure X: Indicators of Unsustainable Current Account Deficit (Proceedings of African Economic Conference)

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