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A country's current account reflects the difference between national saving and investment; persistent deficits mean borrowing from abroad. A current account deficit is sustainable if the economy is growing faster than the real interest rate, making the debt burden shrink relative to income. Large deficits financed by capital inflows can become unsustainable if foreign confidence deteriorates or if underlying imbalances (low saving, high investment) persist.
From the balance of payments, you know that the current account measures a country's net flows of goods, services, and income with the rest of the world, and that a current account deficit is exactly financed by a capital account surplus — the country is borrowing from abroad. This accounting identity is the starting point: CA = S − I, where S is national saving and I is domestic investment. A current account deficit means investment exceeds saving; the gap is filled by foreign capital inflows. The sustainability question asks: can this persist?
The intertemporal approach borrows the logic from the Euler equation and optimal consumption smoothing. A household can borrow today if its future income will be high enough to repay the debt. A country is analogous: borrowing to finance productive investment (building infrastructure, expanding manufacturing capacity) generates the future income needed to service the external debt. This is the good deficit scenario — the US ran large current account deficits in the 19th century as foreign capital financed railroad and industrial expansion, and the debt was eventually paid down from the resulting growth. By contrast, borrowing to finance current consumption rather than productive investment does not generate future repayment capacity and is harder to sustain.
The formal sustainability condition emerges from the debt dynamics equation. If d is the external debt-to-GDP ratio, r is the real interest rate on that debt, and g is the real growth rate of the economy, then the debt ratio grows by approximately (r − g)d plus any new borrowing. If g > r, the economy is growing faster than the interest burden, so even a persistent current account deficit will cause the debt ratio to shrink over time — sustainability is assured as long as the primary balance remains manageable. If r > g, the debt ratio grows without additional borrowing, requiring a primary surplus to stabilize it. The comparison of r versus g is thus the critical diagnostic for sustainability.
However, the formal condition is necessary but not sufficient. Sudden stops can render a technically sustainable position unsustainable in practice. If foreign lenders become nervous about a country's ability to repay — due to political instability, a shift in global risk appetite, or contagion from other crises — they may stop rolling over loans, forcing an abrupt and painful current account adjustment. This is what happened across Southeast Asia in 1997: current account deficits that looked manageable by growth-versus-interest-rate calculations became impossible to sustain when foreign capital dried up overnight. The composition of financing matters too: deficits financed by foreign direct investment (long-term productive capital) are far more stable than deficits financed by short-term portfolio flows or bank lending, which can reverse rapidly. Assessing current account sustainability therefore requires not just arithmetic but judgment about the confidence of foreign creditors and the quality of the underlying investment being financed.