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FRM Part I · FRM Exam Part I · Foreign Exchange Markets

A country records a current account deficit of USD 40 billion and a capital account balance (net capital transfers) of zero. Ignoring errors and omissions, which outcome must hold for the financial account, including reserve assets?

The country must show a net financial inflow of USD 40 billion. The balance of payments sums to zero, so a USD 40 billion current account deficit with a zero capital account has to be financed by net borrowing from abroad, foreign investment inflows or reserve drawdown.

  1. AA net financial inflow (net borrowing from abroad) of USD 40 billionCorrect
  2. BA net financial outflow of USD 40 billion
  3. CA balance of zero
  4. DA net financial inflow of USD 80 billion

Explanation

The balance of payments sums to zero: current account + capital account + financial account = 0. With a current account of -40 and capital account of 0, the financial account must be +40 in net-borrowing terms, meaning the country finances the deficit through net inflows or reserve drawdown. An outflow of 40 has the wrong sign, and 80 double counts.

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