The current account deficit (CAD) increased to 4.4 percent of GDP in the second quarter of 2022-23, up from 2.2 percent the previous quarter, according to the RBI’s quarterly statistics. This represents a reversal from the unusual surplus of 0.9% of GDP in 2020-21. While the merchandise trade deficit has increased in the third quarter of this fiscal year, the CAD may fall.
What is Current Account Deficit (CAD)?
Current Account Deficit (CAD) = Trade Deficit + Net Income + Net Transfers
- A current account is an important component of a country’s balance of payments, which is the account of transactions or exchanges between entities in the country and the rest of the world.
- This includes a country’s net trade in goods and services, net earnings from cross-border investments such as interest and dividends, and net transfer payments such as remittances and foreign aid.
- A CAD occurs when the value of goods and services imported exceeds the value of exports, whereas the trade balance refers to the net balance of goods export and import.
Components of Current Account
Trade Deficit
- Trade Deficit = Imports – Exports
- When a country imports more goods and services than it exports, it is said to have a trade deficit.
- A trade deficit is an economic measure of a country’s negative trade balance, in which imports exceed exports.
- A trade deficit is the movement of domestic currency to foreign markets.
Net Income
- Net Income = Income Earned by MNCs from their investments in India.
- When foreign investment income exceeds domestic savings, the country experiences a net income deficit.
- Payments made to foreigners in the form of dividends on domestic stocks, interest payments on bonds, and wages paid to foreigners working in the country are used to calculate net income.
Net Transfers
- Foreign residents use Net Transfers to send money back to their home countries. It also includes foreigner government grants. It also includes remittances, gifts, and donations, among other things.
- The components of India’s CADs are both desirable and undesirable.
Desirable:
- A desirable deficit is a natural reflection of rising investment, portfolio choices, and the country’s demographics.
- If CADs can be financed by consistent capital inflows, such as FDI inflows, they are desirable because they are less susceptible to capital flight.
- Stable capital flows are desirable because they allow debtor countries, such as India, to use and allocate capital to sectors that can produce long-term productive gains and foster higher economic growth.
Undesirable:
- Large and persistent CADs can be unfavourable if they reflect larger issues, such as low export competitiveness, and are financed by insecure sources.
- There may be cause for concern if deficits are financed by volatile capital flows such as portfolio flows. Portfolio flows are erratic and more vulnerable to reversals in the event of a global financial shock.
Concerns about India’s CAD’s countercyclical nature
- External shock dominance: According to research, the country’s CAD rises when output falls rather than when demand rises, indicating that external shocks dominate.
- For example, if oil prices rise, and because oil is used in the manufacturing process, the cost of production rises, resulting in a decrease in economic growth. In this case, CADs rise with falling growth due to both the inelasticity of oil import demand and its large share of total imports in India.
Challenges and a Path Forward
- The financing’s composition is critical. While FDI inflows were sufficient to cover the deficit in 2021-22, they have been insufficient in the current fiscal year.
- Over the medium term, policymakers must halt the negative spillovers from the global trade slowdown on merchandise exports.
- Further rate hikes by the US Federal Reserve may result in capital outflows, adding to exchange rate market pressures. This could be difficult in the current environment, as a weaker currency combined with a sticky import basket will result in imported inflation.
- Thus, policy measures must facilitate exports by focusing on structural reforms to improve trade competitiveness, as well as signing free trade agreements.
@the end
India is currently dealing with a dual deficit of high fiscal and CADs. While aggressive fiscal consolidation may be unwelcome in the face of mounting concerns about a global slowdown, a comfortable external environment can be maintained by ensuring stable financing and using exchange rates as a shock absorber to weather the adverse global economic situation.
Source: https://www.investopedia.com/terms/c/currentaccountdeficit.asp