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Concerns Over Current Account Deficit

Context

 In its latest review of the economy the Finance Ministry is sanguine about India’s economic recovery and has asserted that major macro-economic risks have subsided over the past six weeks. The Finance Ministry has asserted that the current account deficit (CAD) could, however, deteriorate this year mainly due to rising trade deficits

Relevance

GS Paper 3- Effects of Liberalization on The Economy, Changes in Industrial Policy and their effects on Industrial Growth

Mains Question

How do you define Current Account Deficit? Do you believe that a rising CAD is inherently bad and should be monitored by the country’s central bank? Discuss (250 words)


Current Account Deficit

  • The current account tracks the inflows and outflows of goods, services, and investments into and out of a country. It is a component of a country’s Balance of Payments and, like the capital account, represents a country’s foreign transactions (BOP).
  • A current account deficit exists when the value of goods and services imported exceeds the value of those exported.
  • A country’s current account keeps track of its transactions with other countries, including net income (including interest and dividends) and transfers (such as foreign aid). It is made up of the following parts: Goods trade; Services; and Net earnings on overseas investments and net transfers of payments over time, such as remittances.
  • It is expressed as a percentage of GDP. The CAD formulae are as follows:

Current account = trade deficit + net current transfers + foreign income

Trade deficit = Exports – Imports

  • A rising CAD indicates that a country has become uncompetitive, and investors may be unwilling to invest there.
  • The Current Account Deficit in India could be reduced by increasing exports and reducing non-essential imports such as gold, mobile phones, and electronics.
  • Current Account Deficit and Fiscal Deficit (also known as “budget deficit” is a situation in which a country’s expenditure exceeds its revenues) are known as twin deficits because they frequently reinforce each other, i.e., a high fiscal deficit leads to a higher CAD and vice versa.

Government’s optimism

  • On top of persistent geopolitical strife, the government’s cautious optimism is tinged with impending concerns about 1) a faster tightening of monetary policies by the United States Federal Reserve and 2) the resulting drop in asset markets, which can harm sentiment and consumption.
  • However, for the time being, the central bank’s interest rate hikes and measures to stem the outflow of dollars, along with several steps from the government such as the imposition of windfall taxes and higher import duties on forex-drainers like gold, have been credited with lifting some of the dark clouds over the economy.
  • Despite excise duty cuts on petrol and diesel, the Ministry of Finance believes that India’s fiscal math for the year will not unravel as a result of recent tax levies and healthy Goods and Services Tax collections (that could get healthier as some GST rate hikes kick in from Monday).
  • Industrial metal prices falling to 16-month lows, food prices falling off peaks, and crude oil prices falling in the face of recession fears in many developed countries have all contributed.
  • However, if these fears do not translate into a “sustained and meaningful” drop in food and energy prices, India’s current account deficit will worsen in 2022-23 due to higher imports and weaker merchandise exports, the Ministry has warned..

What affects the Parameters:

  • Because of India’s high reliance on imported fuel, oil price trajectories affect most macroeconomic parameters, including inflation, growth, current account balances, fiscal management, and the rupee.
  • And economic policymakers are right to be concerned about the current account deficit (CAD) widening from 1.2 percent of GDP last year to 2.4 percent this year.
  • There is a vicious circle in play here that may take some time to break.
  • Slowing exports and costlier inelastic imports of oil have resulted in record merchandise trade deficits for two months in a row, exacerbating the CAD, which is outpacing the rupee, making imports even more expensive, and widening the CAD even more.

Way Forward

If the fiscal deficit is not a concern, and tax revenues may in fact exceed Budget estimates due to high inflation, the government can reconsider its fiscal capacity and consider additional measures to stimulate growth and mitigate the negative effects of high inflation and interest rates on consumption and investment.


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October 2022
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