A deficit that is financed by net capital flows from the rest of the world, and therefore corresponds to a surplus on the capital account, is known as which type of deficit?

Introduction / Context:
The balance of payments of a country records all economic transactions between residents and the rest of the world. It is divided into the current account, which records trade in goods and services and income flows, and the capital and financial account, which records capital flows such as foreign investment and borrowing. When one part of the balance of payments is in deficit, another part must adjust so that the overall balance of payments still balances. This question focuses on recognising that a deficit financed by net capital inflows is a current account deficit.

Given Data / Assumptions:
• There is a deficit that is being financed by net capital flows from the rest of the world. • These net capital flows show up as a surplus on the capital and financial account. • We must identify which type of deficit corresponds to this situation. • The options include current account deficit and various other account deficits.

Concept / Approach:
In the balance of payments, a current account deficit occurs when the value of imports of goods and services plus net income and transfers paid to the rest of the world exceeds the value of exports and net receipts. This deficit must be financed either by drawing down foreign exchange reserves or by net capital inflows, such as foreign direct investment, portfolio flows or external borrowing. When it is financed by net capital inflows, the capital and financial account shows a corresponding surplus. Thus, a deficit that is matched by a capital account surplus is by definition a current account deficit.

Step-by-Step Solution:
Step 1: Recall that the balance of payments identity requires that the sum of the current account, capital and financial account and changes in reserves must equal zero. Step 2: If there is a surplus on the capital and financial account due to net capital inflows, this means that net foreign investment into the country is positive. Step 3: These inflows must finance either a current account deficit or an increase in foreign exchange reserves or a combination of both. Step 4: The question states that the deficit is financed by net capital flows, suggesting that the capital account surplus is offsetting the deficit in another part of the balance of payments. Step 5: The relevant deficit in this context is the current account deficit, which is the standard term used when a country imports more goods, services and income than it exports and makes up the difference through borrowing or investment inflows. Step 6: Therefore, the correct term for the deficit described is current account deficit.

Verification / Alternative check:
Consider a simple example. Suppose a country has a current account deficit equal to 3 per cent of its gross domestic product. If it attracts net foreign investment equal to 3 per cent of gross domestic product, then the capital account records a surplus of that amount, and the balance of payments overall balances without needing significant changes in reserves. This is exactly the situation described in the question, where net capital inflows finance a deficit and the relevant term used in policy discussions is current account deficit.

Why Other Options Are Wrong:
Savings account deficit is not a standard term in balance of payments analysis. Although national saving is related to current account balance, the phrase itself is not used in this context.

Capital account deficit refers to the opposite situation, where there is a net outflow of capital rather than a net inflow. In that case, the capital account would be in deficit and would need to be financed by a current account surplus or reserve drawdown.

Asset account deficit is again not a conventional term in balance of payments statistics and does not accurately describe the relationship between current account and capital account flows.

Common Pitfalls:
Learners sometimes confuse the terms current account and capital account because both involve international transactions. Another pitfall is to think that any deficit financed by foreign funds must be a capital account deficit, ignoring the fact that capital flows themselves are part of the capital account. Keeping in mind the basic identity that a current account deficit is equal to net capital inflows minus changes in reserves helps in correctly identifying such situations in questions and in real world policy debates.

Final Answer:
A deficit that is financed by net capital flows from the rest of the world and corresponds to a capital account surplus is a Current account deficit.