Current Account Balance

Definition

The current account balance is one of the two main metrics of the nature of a country's foreign trade; the other is the net capital out flow. The current account surplus signifies an increase in a country's net foreign assets by the corresponding amount, and a current account deficit indicates the exact opposite. It is referred to as the current account because it computes the goods and services consumed in the current economic period.

Why is it important?

Although it is released on a quarterly basis, it is very important in directing the federal board on their decisions regarding monetary policy. This is simply for the reason that a deficit in the balance may spell disaster to the economy and the fed may be forced to put up measures to try to correct the imbalance. If the fed deems it necessary, they might try to give incentives such as lower interest rates to attract local production that will increase the current account balance deficit.

How is it calculated?

Since the current account balance is very much dependent on the balance of trade, it is therefore calculated by computing the net factor income from abroad and adding it to the net unilateral transfers from abroad. Current account surplus is usually associated with positive net exports.

The income account, which is a sub-account of the current account, is 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 but also to the money sent by individuals working abroad, technically referred to as remittances to their families back home. If the country has a negative income account these results in the central bank, paying more than it earns from interests and dividends among others. The various subcategories in the income account are linked to specific subcategories in the capital account, as income is often composed of factor payments from the ownership of assets or debts abroad

How does it affect forex trading?

The forex rate is the one directly affected by the trends of the current account balance. It is so direct that the two will move in the exact same direction. A deficit in current account balance simply signifies diminishing foreign currency reserves. This situation may put the economy in a complex situation as doing business internationally may prove difficult or too expensive if the state has to buy foreign currency at higher interest rates to transact business. If the trend persists, then other foreigners may try to avoid transacting any business in U.S. dollars if the value is perceived to decline. In similar fashion, a current account surplus signifies that the country is doing much business internationally and they thus have enough foreign currency reserves a trend that will strengthen the exchange rate of the dollar against other currencies. If the foreign currency reserves are in surplus the federal bank can comfortably decide forex rates without any external pressures, however if it is in deficit then the federal bank has to bend to the directions of other stronger currencies.

Effect on the stock market

The current account balance affects the stock market in an indirect manner. Since the stock market is generally driven by perceptions and speculations about the possibility of growth or recess, the status of the current account balance will give an indication to investors about possible good or bad times. In their speculative nature, the investors may start shifting their holdings in fear of loses or in anticipation of growth depending on the perception they get from the forex rates which are in turn directly determined by the current account balance. If the rates are persistently dropping and the investors anticipate economic decline, they may as well be inspired to shift to perceived better performing economies. Many a times, investors take keen interest at the rates of interest offered by the federal bank because it may grossly influence their investment returns. Since the current account deficit is mainly because of declining exports. It mainly points to the fact that companies are either reducing production for one reason or the other. It is therefore likely to change the investors’ attitude towards the country’s economic status.

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