Current Account Definition

DailyForex.com Team

A current account records the net value of exports and imports of goods and services plus international transfers of capital, net earnings, cross-border investments, and financial aid of a country over a set period, monthly, quarterly, or annually. 

For individuals, a current account refers to a bank account used for day-to-day operations. Most receive their salary and pay their bills via bank-to-bank transfers. It usually comes with a debit card, allowing individuals to conduct financial transactions electronically. 

Why does a Current Account Matter? 

Investors will evaluate the current account balance of a country to assess its economic health. A current account surplus means that a country exported more goods and services than it received, is a net creditor to its trading partners, and generally indicates a well-functioning financial system. A current account deficit suggests a country imports more than it exports, owes money to its trading partners, and is one sign of structural economic issues that often linger below the surface. For example, the Eurozone economy, driven by Germany, generally prints a current account surplus, while the US constantly records a current account deficit. 

Consumers and governments should always strive for a current account surplus, which means that after receiving all income and paying all expenses, the balance is higher than before. Individuals should aim to spend less than they receive, known as living within their means, to avoid debt. While governments should follow the same principle, they tend to overborrow, explaining the massive debt mountain, which topped $303 trillion per the latest Institute of International Finance (IIF) data. 

The Current Account Definition 

A current account represents the financial outflow (exports) and inflow (imports). It belongs to the balance of payments (BOP), which records all monetary transactions with its trading partners. 

The current account measures the following: 

  • The value of exports and imports of goods and services (balance of trade) 

  • Net primary income or factor income (earnings on foreign investments minus payments to foreign investors) 

  • Net unilateral transfers 

The balance of payments consists of: 

  • Capital account (physical assets, like buildings, factories, etc.) 

  • Financial account (investment portfolios active in capital flows) 

A current account for individuals records the net income and outflows. Unlike governments, banks usually do not allow deficits. Consumers can apply for credit cards and personal loans. The former is not reflected in the current account, while the latter appears as income, offset by a separate credit account.  

Answering the “what is current account” question helps clarify the importance of balancing incomes and outflows, aiming for a current account surplus while avoiding a current account deficit.  

Understanding Current Account 

Half of the balance of payments consists of the current account. The other is the capital account, which includes the financial account. It also represents a significant part of foreign trade together with net capital outflow. 

Current account vs. Capital account 

  • A current account measures exports, imports, net income, asset income, and direct transfers  

  • A capital account measures the net flow of investments and includes physical assets, reflecting the net change in asset ownership 

Current account vs. Financial account 

  • A current account measures transactions of a country with trading partners 

  • A financial account measures investment portfolios, direct investment, portfolio investment, reserve assets, and liabilities to foreign investors 

Current account vs. Savings account (for consumers) 

  • A current account records all incomes (for example, salary) and outflows (for example, rent, utility payments, debt payments) of a consumer 

  • A savings account does not support capital outflows for expenditures and earns an interest rate on deposits 

What is the current account ratio? 

The current account ratio is a liquidity measure, dividing income by outflows. Investors can use it to assess the health of an economy, measure its short-term sustainability, and make investment decisions based on the current account ratio versus competing investment ideas. 

What are the current account components? 

A current account consists of four primary components, where the trade balance usually determines a surplus or deficit. The exchange rate has a notable impact on the trade balance. Export-oriented economies prefer a weak domestic currency, despite its inflationary contributions, as it makes goods cheaper for foreign buyers. 

The four current account components are: 

  1. Trade Balance - The sum of all exports and imports of goods and services. A trade deficit usually offsets any net earnings in other categories, which is why governments with trade deficits focus on improving exports while championing domestic consumption. Trade deficits create internal imbalances, highlight structural challenges, and cause long-term issues. 

The Top Ten countries with a current account surplus are: 

  • Germany 

  • Japan 

  • China 

  • The Netherlands 

  • Switzerland 

  • Russia 

  • Taiwan 

  • Singapore 

  • South Korea 

  • Italy 

The Top Ten countries with a current account deficit are: 

  • US 

  • UK 

  • Kenya 

  • Brazil 

  • Ireland 

  • Canada 

  • Indonesia 

  • India 

  • Algeria 

  • France 

  1. Net Income - It consists of foreign income received by residents and income paid to foreigners. 

Foreign income received consists of: 

  • Salaries and benefits by residents working overseas 

  • Interest and dividends by residents on foreign assets 

Income paid to foreigners consists of: 

  • Wages paid to foreigners 

  • Interest and dividends paid to foreigners who own assets in the country 

  1. Direct Transfers - The net income and outflows of capital between governments and overseas residents sending money to their home country. Some economies, especially in emerging and frontier countries, rely heavily on remittances, as many households have one member abroad to earn higher wages and support families. For example, Tonga relies on remittances for almost 40% of its GDP. 

Direct transfers include: 

  • Remittances from workers oversees who send money to their home country 

  • Direct foreign aid by a government 

  • Foreign direct investment (FDI), which must exceed 10% of the capital of the foreign investor to classify 

  • Bank loans to foreigners 

  1. Asset Income (active and passive) - The net effect of changes in assets consisting of bank deposits, central bank balance sheets, government reserves, securities, and real estate.  

Asset income includes: 

  • Deposits at foreign banks and income generated from accumulated interest 

  • Bank loans to foreigners and interest payments received 

  • Sales of foreign-based securities and other assets 

  • Foreign direct investment into a foreign country 

  • Debts owed by foreigners 

  • Government ownership of foreign assets 

  • Reserve assets held by central banks in foreign currencies 

Asset outflow includes: 

  • Liabilities to foreigners, including their domestic bank deposits 

  • Loans made by foreign banks to domestic banks 

  • Foreign purchases of government debt and associated service costs 

  • Sales of securities to foreigners and related dividend payments 

  • Foreign direct investment and reinvested earnings, dividends, and debt 

  • Domestic assets held by foreign governments 

  • Net transfer of a domestic currency to a foreign government 

What Does the Current Account Reveal about an Economy? 

Knowing the “what is current account” definition allows market participants to understand the health of an economy. 

An economy running a current account surplus absorbs less than it produces, growing its currency reserves and saving money, which it can invest in other economies and accumulate assets. 

An economy running a current account deficit absorbs more than it produces, accumulates debt from trading partners, and depletes its foreign assets. It also suggests reckless, short-sighted fiscal and monetary policy if the deficit results from trade imbalances. Some argue that one created by high foreign investment and low savings could suggest a productive economy expanding internationally. 

Current Account Balance Explained 

The current account balance reflects the net income or deficit of a country. It equals the capital account balance but in the opposite direction. 

A current account surplus results when a country exports more than it imports. It increases capital reserves and results in a country being a net lender to its trading partners, confirming a healthy economy. A positive current account example is Germany. 

A current account deficit occurs when a country imports more than it exports, which can lower capital reserves, making the country a net borrower and suggesting structural economic issues. A negative current account example is the US. 

How to Calculate the Current Account Balance? 

The current account calculation relies on a simple mathematical formula, which shows analysts if a country runs a surplus or a deficit. It also highlights discrepancies and areas for restructuring. 

The current account formula is: 

CAB = (X−M) + (NY+NCT) 

  • X = Exports of goods and services 

  • M = Imports of goods and services 

  • NY = Net income abroad 

  • NCT = Net current transfers 

Current Account Deficit Explained 

A current account deficit shows that a country imports more than it exports, making it a net borrower. Investments exceed savings, and the economy relies on foreign resources to meet domestic requirements for consumption and investment. 

During economic expansion, many ignore a current account deficit. For example, the US remains the most significant debtor globally, but not many pay attention to its twin deficits, with a debt-to-GDP ratio exceeding 100%. When the Greek debt-to-GDP ratio exceeded 100%+, its economy neared collapse and required bailouts. During a recession, more scrutiny applies, but a long-term or chronic current account deficit will eventually harm any economy, as evident by persistent structural issues in the US. 

What is the Difference Between the Current Account versus Other Accounts? 

The primary difference remains the input to calculate a current account versus other accounts. Each reflects a different segment.  

The balance of payments consists of the current, capital, and financial accounts. They measure the balance of trade and international transfer of capital, asset ownership changes, and investment portfolio capital flows, respectively. 

For consumers, a current account offers the primary source to receive income and pay expenses. Consumers must understand the current balance and available balance differential.  

Current Account Conclusion 

A current account offers insights into the health of an economy and its sustainability and provides clues about the effect of its fiscal and monetary policy. It consists of the trade balance, net income, direct transfers, and asset income. The current account is part of the balance of payments. A well-managed economy generally prints a surplus, while one with structural issues records a deficit, resulting in a downward spiral. 

FAQs 

What are the four parts of current accounts? 

The four components of current accounts are trade, net income, direct transfers, and asset income. 

Who can open a current account? 

A current account for consumers is available for all residents above 18 years of age. 

What is the benefit of a current account? 

A current account lists all income and expenses, offering a snapshot of the financial health of governments and consumers. 

Is a cheque account the same as a current account? 

Both accounts serve consumers the same purpose, and some current accounts offer cheques, but most rely on debit cards, as few countries continue using cheques. 

How to open a current account? 

A consumer can open a current account online or at the local branch of their selected bank. 

DailyForex.com Team
The DailyForex.com team is comprised of analysts and researchers from around the world who watch the market throughout the day to provide you with unique perspectives and helpful analysis that can help improve your Forex trading.

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