Question : When a country's current account deficit increases, its capital account balance is likely to:
Option 1: Increase
Option 2: Decrease
Option 3: Remain unchanged
Option 4: It is not related to the current account deficit
Correct Answer: Decrease
Solution : The correct answer is (b) Decrease.
The current account and capital account are interconnected in the Balance of Payments. A current account deficit means that a country is importing more goods and services, or it is earning less from its exports, compared to its expenditures on imports. This implies a net outflow of funds from the country.
To finance the current account deficit, the country may need to attract capital from foreign sources. This can be done through the capital account, which records financial transactions involving changes in ownership of non-financial assets and capital transfers.
An increased current account deficit indicates a greater need for capital inflows to balance the deficit. Therefore, it is likely that the capital account balance will decrease as a result of the increased current account deficit.
To summarize, an increase in the current account deficit is likely to lead to a decrease in the capital account balance.
