Recent trend of Current Account Deficit (CAD)

Context:  The recent data indicated that the current account deficit (CAD) will moderate despite the global slowdown triggered by rising inflation and interest rates.

• According to the RBI, the CAD is expected to moderate in the second half of 2022-23 and remain eminently manageable and within the parameters of viability.

About Current Account and Current Account Deficit:

• A nation’s Current Account maintains a record of the country’s transactions with other nations. It comprises the following components:
  • trade of goods and services,
  • net earnings on overseas investments and net transfer of payments over a period of time, such as remittances
  • This account goes into a deficit when money sent outward exceeds that coming inward.
• Calculation:
  • It is measured as a percentage of GDP.
  • Trade gap = Exports – Imports.
  • Current Account = Trade gap + Net current transfers + Net income abroad.

Current Account Deficit:

• When the value of the goods and services that a country imports exceed the value of the products it exports, it is called the current account deficit.
• CAD and the fiscal deficit together make up the twin deficits – the enemies of the stock market and investors.
• Difference with the Balance of Trade:
  • It is slightly different from the Balance of Trade, which measures only the gap in earnings and expenditure on exports and imports of goods and services.
• Whereas, the current account also factors in the payments from domestic capital deployed overseas.
• For example, rental income from an Indian owning a house in the UK would be computed in the Current Account, but not in the Balance of Trade.

Significance of CA:

• If the current account – the country’s trade and transactions with other countries – shows surplus, that indicates money is flowing into the country, boosting the foreign exchange reserves and the value of rupee against the dollar.
• These are factors that will have ramifications on the economy and the stock markets as well as on returns on investments by people.

Indicator of Economy:

• CAD may be a positive or negative indicator for an economy depending upon why it is running a deficit.
• Foreign capital is seen to have been used to finance investments in many economies.
• It may help a debtor nation in the short-term, but it may worry in the long-term as investors begin raising concerns over adequate return on their investments.
• India’s current account position is largely on the deficit side because of the country’s dependence on oil imports.

Ways of reducing CAD:

• The Current Account Deficit can be reduced by boosting exports and curbing non-essential imports such as gold, mobiles, and electronics.

The moderation in CAD, expected to be aided by the following factors:

• The fall in commodity prices,
• Rising worker’s remittances and services exports, and
• Abatement of selling pressure by foreign investors, is set to boost sentiment on the investment front, as it will also bring the pressure off the currency.

Reasons for narrowing trade deficit in recent times:

• The trade deficit (for Jan 2023) narrowed to $17.7 billion, led by a sharp fall in imports, while exports fell by a smaller amount.
• The sharp drop in imports was due to:
  • Non-oil imports falling, mainly due to a price impact (softening in coal prices from mid-December),
  • Likely softening in domestic demand post the festive season (such as lower imports of transport equipment), and
  • Seasonal impact of the Chinese New Year holidays.

WAY Forward:

While rising CAD raises concerns among investors as it hurts the currency and thereby the inflow of funds into the markets, a notable decline in CAD has improved market sentiments. Experts believe that CAD is very important for the currency. The value of an economy hinges a lot on the value of its currency and thereby, it also supports the equity markets by keeping the fund flow intact.

Source:  Indian Express

Previous Year Questions

Q.1) With reference to the Indian economy, consider the following statements:

1. An increase in Nominal Effective Exchange Rate (NEER) indicates the appreciation of rupee.
2. An increase in the Real Effective Exchange Rate (REER) indicates an improvement in trade competitiveness.
3. An increasing trend in domestic inflation relative to inflation in other countries is likely to cause an increasing divergence between NEER and REER.

Which of the above statements are correct? (2022)

1. 1 and 2 only
2. 2 and 3 only
3. 1 and 3 only
4. 1, 2 and 3

Q.2) With reference to the Indian economy, consider the following statements:

1. If the inflation is too high, Reserve Bank of India (RBI) is likely to buy government securities.
2. If the rupee is rapidly depreciating, RBI is likely to sell dollars in the market.
3. If interest rates in the USA or European Union were to fall, that is likely to induce RBI to buy dollars.

Which of the statements given above are correct? (2022)

1. 1 and 2 only
2. 2 and 3 only
3. 1 and 3 only
4. 1, 2 and 3