Short-term deficits in the current account of the balance of payments can be financed by balancing with the

1. Analyze the question The question asks how a short-term deficit in the current account of the balance of payments (BOP) is financed or balanced.

2. Explain the concept The balance of payments has two main parts:

• Current account: records trade in goods (visible trade), trade in services (invisible trade), income, and transfers.
• Capital (and financial) account: records capital flows such as foreign loans, foreign investment, and changes in external reserves.

In theory the BOP must balance. A deficit in the current account means the country is spending more abroad than it earns. The gap must be covered by a surplus somewhere else, which means inflows on the capital account. These inflows include:

• borrowing from foreign countries or from institutions like the IMF and World Bank,
• foreign direct and portfolio investment,
• drawing down foreign exchange reserves, which is recorded in the financial account.

3. Solution

• A. Invisible account: This is part of the current account (services, income and transfers). It cannot be used to finance a deficit in the account it belongs to.
• B. Capital account: Correct. Short-term borrowing, capital inflows and the use of reserves are recorded here, and they offset the current account deficit.
• C. Visible account: This is the trade in goods and is also part of the current account.
• D. National income account: This measures GDP and national output. It is not a component of the BOP.

4. Answer The correct option is **B.

5. Exam tip Remember this rule: Current account + Capital account = Balance (zero). If the current account is in deficit, the capital account must be in surplus to balance it. Visible and invisible trade are both inside the current account, so they can never be the answer to a question about how to finance a current account deficit.