In recent years South Africa’s current account deficit – the gap between revenue on exports of goods and services and the import bill – has grown worryingly large. In the third quarter of 2007 the deficit peaked at 8.7 percent of gross domestic product (GDP), with the source of such a sizable gap ascribed primarily to a ‘secular decline’ in the country’s export volumes.

So what? Simply put, such a large deficit is a clear indication that South Africa is living beyond its means. The South African economy is heavily dependent on portfolio inflows, with foreign capital constituting a significant portion of the country’s capital account. Such portfolio flows, particularly into emerging economies, are notoriously volatile and sensitive to international investors’ risk perceptions, a reality accentuated in the aftermath of the global financial crisis. A heavy dependence on portfolio flows to finance the current account deficit has exposed the South African economy to a significant degree of vulnerability. In addition, a high current account deficit also poses a significant threat to currency stability, with currency volatility potentially affecting exporters or importers in the country depending on the direction of the volatility.

To date, the size of the country’s current account deficit has fluctuated significantly during the course of 2009. The deficit widened considerably in the first quarter of 2009 to more than 7 percent (up from 5.8 percent in the final quarter of 2008), growing again towards its 2007 peak. Much of this was due to a sharp plunge of 21 percent in exports in conjunction with a correspondingly less severe decline in import volumes (just 8.4 percent). According to the South African Reserve Bank, “since almost half of the county’s merchandise exports are destined for the US, Europe and Japan, the decline in real production in these economies severely affected the volume of merchandise exports in the first quarter of 2009.”

Despite this relatively gloomy picture at the start of the year, there have been robust signs that the deficit is narrowing. Indeed, between the first and second quarters, the negative balance on the current account fell sharply from 7 percent to 3.2 percent of GDP.

Is the reduction in the deficit likely to persist in the medium to long term? The source of the narrowing of the deficit may provide some indication. Much of the boost to the current account has come on the back of the recession, with a contraction in real GDP and domestic economic activity since the middle of 2008 starting to bite. This has been accompanied by a simultaneously sizable drop in the volume of merchandise imports as a result of subdued domestic demand and weak business and consumer confidence. These factors combined to see the deficit narrow to its lowest level in more than five years.

While the decline in the deficit is undoubtedly encouraging, it is important to be mindful of the fact that much of the decline can be attributed to the effect of the global economic crisis. Nevertheless, the growing appetite for risk together with improved capital inflows that will accompany the eventual revival of the global economy are likely to narrow the current account deficit further in the near future.