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IAI Actuarial Core Principles · Business Economics · Impact of the macroeconomic environment on business

Which statement about a country running a persistent current account deficit financed by foreign portfolio inflows is most accurate, and why does it matter to domestic businesses?

A deficit financed by portfolio inflows depends on continued foreign willingness to invest. If inflows suddenly stop or reverse, the currency can depreciate sharply and interest rates may rise, raising costs for domestic firms, especially those with unhedged foreign borrowing.

  1. AIt is sustainable only while foreign investors keep funding it, so a sudden stop can cause depreciation and higher borrowing costsCorrect
  2. BIt implies the capital account must also be in deficit by the same amount
  3. CIt shows that the exchange rate cannot move
  4. DIt guarantees that domestic interest rates will fall
  5. It means exports exceed imports of goods and services

Explanation

A current account deficit must be matched by a capital and financial account surplus (or reserve use). If portfolio inflows reverse, the currency can depreciate and interest rates rise, hurting firms with foreign-currency debt or needing finance. The other options contradict the balance of payments identity.

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