The current account deficit (CAD) has reached a nine-year high.

India’s current account balance recorded a deficit of $36.4 billion (or 4.4% of GDP) in the September quarter, up from $18.2 billion (2.2% of GDP) in the previous quarter.

Current Account Deficit (CAD)

  • 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 exported and imported.

Components of Current Account

Current Account Deficit (CAD) =  Trade Deficit + Net Income + Net Transfers

(1) 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.

(2) Net Income

  • Net Income = Income earned by multinational corporations from their investments in India.
  • When foreign investment income exceeds domestic savings, the country experiences a net income deficit.
  • Foreign investment can assist a country’s economy is growth. However, if foreign investors are concerned that they will not receive a reasonable return in a reasonable amount of time, they will cut off funding.
  • Net income is measured by the following things:
  • Dividends on domestic stocks are paid to foreigners.
  • Bond interest payments.
  • Wages for foreign workers in the country.

(3) Net Transfers

  • Foreign residents use Net Transfers to send money back to their home countries. It also includes foreign government grants.
  • It includes remittances, gifts, and donations, among other things.

How does a current account transaction occur?

  • Understanding the Current Account Deficit in detail requires an understanding of what current account transactions are.
  • Current account transactions necessitate the use of foreign currency.
  • The following transactions are associated with which component:
  • Component 1: Payments related to foreign trade – import and export
  • Component 2: Interest on loans to other countries and net income from foreign investments
  • Component 3: Remittances for living expenses of parents, spouses, and children living abroad, as well as expenses associated with foreign travel, education, and medical care for parents, spouses, and children.

Reasons for the current account deficit

  • Intensifying geopolitical tensions and supply chain disruptions have caused crude oil and commodity prices to skyrocket, putting upward pressure on the import bill.
  • The rise in coal, natural gas, fertilizer, and edible oil prices has exacerbated the trade deficit.
  • However, as global demand has increased, so have merchandise exports.

Effects of a large CAD on the economy

  • A large CAD will increase demand for foreign currency, causing the home currency to depreciate.
  • Nations reduce CAD by attracting capital inflows and running capital account surpluses through increased foreign direct investment (FDI).
  • However, worsening CAD will put pressure on capital account inflows.
  • Nonetheless, if an increase in the import bill is due to imports for technological advancement, it will benefit long-term development.
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