Vulnerabilities and consequences of a excessive current account deficit in relation to GDO in three countries, Estonia, Iceland and Latvia?
Current Accounts are ......... they (research in economics book in library).
Records transactions arising from trade in goods and services. It also includes net investment income earned from foreign asset holdings.
By delving into these issues and the stereotyped unhealthy current account deficit,
Possible vulnerabilities that countries are leaving themselves susceptible to.
Further beyond this the consequences for both the individual country itself and repercussions on interrelated countries in the now global economy.
In terms of the possible vulnerabilities and consequences,
Iceland, Estonia and Latvia
a collection of countries.
Some of the reasons why the three countries run current account deficits and continue to
1) Current Account Deficit
A deficit in the current account can be construed as a country importing more than they are currently exporting. Numerous countries in fact run current account deficits, most notably some of the world's major economy players such as the United States of America.
Although when current account balance is present in terms of Gross domestic product,
Stark contrasts as some countries do poorer
Proportionally deficit takes on a different look (Form),
This is evidently the case when looking at Estonia, Iceland and Latvia.
With respective 2007 figures of -18.065, -15.36 and -22.557 (IMF, World Economic Outlook Database, April 2009) of current account balance in percent of GDP. Which are excessively high in comparison to the majority of countries around the world and in contrast to USA's -5.296.
Reasoning behind this excess financing is the increase of consumption, an example being Estonia growing and increasing GDP the finance from abroad made it possible to continue consumption levels and investments.
This needs repayed in the future but it
One of the ways to attract more money in the economy is foreign investment, in the cases of the three countries a large amount of foreign investment was taken on in order to stimulate economy.
2) External Financing - Short Term Loans
Iceland in particular embraced the chance to finance their spending via foreign investment, significantly through availability of bank loans. This finance was via the use of short term loans,
Through the use of short-term loans Latvia has been able to finance their own current account deficit, yet this relies on the availability of finance.
The three major banks in Iceland gambled on this
‘By the end of 2007, Iceland's three largest banks relied on short-term financing for 75% of their funds, mostly through borrowing in the money markets and in the short-term interbank market.' (
Liquidity is very high yet this can have reverse effects
‘government auction to sell 50 million lats ($100.8 million) of short-term debt failed to attract any bidders' (WSJ Journal)
This failure to sell then leads to problems in
Theories upon the debt which
External Finance - Investment mismatch
With large amounts of foreign investment being pumped into Iceland's economy, investments were made to correct current account deficit by maturing loans.
‘We also find that firm with higher exposure are less likely to access new debt
ﬁnancing following as low down in capital inﬂows, suggesting they are forced to obtain ﬁnancing for their production and investment elsewhere, be it internal or by seeking external sources of equity
ﬁnancing.' (Maturity Mismatch)
By channelling such amounts of money into long term loans, liquidity was reduced beyond this going back to the current account deficit starts to cause problems as the amount of money in reverses is reduced.
Financing in Iceland was also in trouble due to the fact that with the central bank having limited reverses, especially in comparison to the assets the main banks held abroad the debt taken on was too large to fund in the short-term.
Like with consumption the financing of such short term loans is ok until finance is removed.
Maturity mismatching is a common way, and if completed correctly then will give larger return on money as interest rates are higher.
Estonia did try to combat and subdue such problems by creating such a war chest in reverse to increase liquidity.
Currency and banking crises occur everywhere from time to time, but they have been especially virulent in developing countries because they are usually accompanied by a ‘sudden stop' in capital inflows, i.e. a loss of access to external finance (Calvo and Reinhart, 1999).
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