Impact of Current Account Deficit on Foreign Exchange Reserves

Hard International Economics Balance Of Payments

In the context of the balance of payments (BOP), a country records various transactions that reflect its economic interactions with other countries. The BOP is divided into two primary accounts: the current account and the capital and financial account. An important concept related to these accounts is the relationship between a country's current account balance and its foreign exchange reserves.

Which of the following statements best describes the impact of a prolonged current account deficit on a country's foreign exchange reserves?

A prolonged current account deficit increases foreign exchange reserves as the country borrows from abroad.

A prolonged current account deficit decreases foreign exchange reserves since it implies the country is spending more on foreign goods and services than it is earning.

A prolonged current account deficit has no impact on foreign exchange reserves if the capital account is in surplus.

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