When is a current account deficit considered more sustainable?

A current account deficit is considered more sustainable when it is financed through foreign direct investment (FDI) rather than through debt. This is because FDI typically involves long-term investment in physical assets or businesses, contributing to an increase in the productive capacity of the economy. It can create jobs, improve infrastructure, and enhance technology transfer, thereby supporting economic growth over the long term.

In contrast, financing a current account deficit through debt can lead to repayment obligations that may become burdensome, particularly if the country does not generate enough income to service this debt. Debt financing can also increase vulnerability to external shocks and lead to currency depreciation, making it difficult to maintain fiscal stability.

Furthermore, while financing through domestic savings is beneficial, it may not be sufficient to cover a current account deficit, particularly if the savings rate is low or insufficient to support the necessary investment. Likewise, covering a deficit with foreign reserves is a temporary measure that does not address the underlying economic conditions that lead to a deficit, risking depletion of reserves and potential balance of payments crises.

Thus, FDI represents a more enduring and sustainable financing method for a current account deficit, fostering growth and reducing reliance on external debt.