Context: The data released by RBI for the last quarter of the financial year reported the current account deficit of India at 0.2% of GDP.
- It is a significant decline given the CAD of previous quarter was 0.9% of GDP and 2.7% of the GDP for the same quarter of previous year.
Factors for decline of CAD
- A lower trade deficit and a rise in net services receipts has led to the decline of CAD.
- Net services receipts increased on the back of a rise in net earnings from computer, travel and financial services.
- Private transfer receipts, mainly representing remittances by Indians employed overseas, went up by 9%.
- Also, as India is a net importer when it comes to crude oil, and it also has inelastic demand, so movement in crude oil prices tend to have a significant bearing on CAD.
Is a contraction in CAD beneficial for India ?
A decline in CAD may be deemed to be beneficial during a normal growth year.
- But when the country is experiencing a slowdown, it becomes a cause of concern.
- It is so because, if we see the example of India, then India imports most of the items for self consumption. So the contraction of CAD ultimately becomes a sign of weak demand rather than an advanced trade position.
- It can also be seen as low growth leading resulting in lower imports. So when the growth cycle reappears, imports will tend to rise.
So the need of the hour for RBI is to keep a vigil at the value of the rupee to avoid its appreciation due to a lower CAD.
What is the Current Account ?
- Current account represents foreign transactions of a country and a component of BoP( Balance of Payment).
- It is a measure of the flow of goods, services, and investments coming in and going out of the country.
Components of the Current Account
- Net Trade in Goods
- Net Trade in Invisibles
- Net trade in Services
- Net Income
- Comprises Profits, interest, and dividends
- It can also be defined as income earned by residents from the rest of the world minus the income paid to foreigners.
- Net Transfers
- Comprises Gifts, Remittances, and Transfers
Current Account Deficit
- A deficit is reported in the Current Account when the Net trade in Goods and invisibles is skewed in favor of imports than exports of the same.
- In other words, it measures the difference between the value of a country's imported and exported goods and services.
- It is measured as a percentage of GDP.
CAD = Net (Balance of Trade + Balance of Invisibles)
Balance of Trade = Net (Trade in Merchandise Goods)
Balance of Invisibles = Net (Services +Income + Transfers)
Pros and Cons of CAD
- CAD is not necessarily bad
- It can be used to finance Capital goods in order to boost export capabilities of consumer goods.
- If CAD is being neutralised by FDIs, then it is a positive investment that will boost the growth cycle.
- Downsides of CAD
- If borrowing is being used to finance CAD, then it becomes unsustainable as it will lead to higher interest payments.
- If financed by Capital flows (Hot money, FPIs) then it entails a risk of hot money flowing out in times of slowdown. Withdrawal of hot money leads to rapid devaluation of currency. Eg. East Asian Crisis
Impacts of Rising CAD
- It is an indication of the economy getting uncompetitive.
- It may lead to crowding out of investors.
- Fiscal Deficit along with CAD, is termed as Twin deficit and is indicator of Macroeconomic prospects of a country.
- It is often seen as both tend to reinforce each other i.e. a high fiscal deficit leads to higher CAD and vice versa.