A current account deficit occurs when receipts on current account are less than payments on the current account. This means that the country is spending more than it receives from sales to the rest of the world.

When a nation has a deficit current account, it means that the nation is a borrower from other countries. Just like an individual who spends more than her income must finance the difference by selling assets or by borrowing, a country with a deficit must do the same.

A current account deficit must be financed by a capital account surplus, that is, a net capital inflow. The equation Current account + Capital account = 0 shows that any deficit in the current account is balanced by a surplus in the capital account through international lending.

Alternatively, the country could use its reserves of foreign exchange to balance the deficit. The reserve bank sells foreign exchange when there is a deficit, called official reserve sale. The monetary authorities are the ultimate financiers of any deficit in the balance of payments.

Thus, a current account deficit need not be a cause for alarm if it is financed sustainably through capital inflows or reserves. It becomes a concern only if the deficit persists without adequate financing mechanisms.