Rising Current Account Deficit

• 13 Nov 2021

Why in News

According to a recent report by British brokerage Barclays, India's trade deficit has been jumping continuously since July 2021. The widening Current Account Deficit (CAD) is driven by the massive spike in commodity prices led by crude oil.

• The CAD is expected to reach $45 billion or 1.4% of GDP by March 2021. This will put pressure on the fragile economic recovery.

Key Points

• Definition: A current account deficit occurs when the total value of goods and services a country imports exceeds the total value of goods and services it exports.
  
  • The balance of exports and imports of goods is referred to as the trade balance. Trade Balance is a part of ‘Current Account Balance’.
• Factor involved in India’s Current Account Deficit:
  
  • High Oil Imports: In India, close to 85% of the oil demand is met through imports.
    
    • Due to this it is estimated that every $10 per barrel rise in global crude prices will widen the trade deficit by $12 billion or 35 bps of Gross Domestic Product (GDP).
  • High Gold Imports: Another force driving down the foreign exchange is gold imports.
    
    • Recovering domestic demand and the ongoing festive season are boosting Gold imports.
    • The World Gold Council expects gold demand this year to surpass the 2020 levels and it expects the demand for gold to remain high given the rising wealth effects and incomes.
  • Services, the Positive side: The report held that the monthly services surplus has improved from an average of $6.6 billion in 2019 to $7 billion in 2020, and to $8 billion in the first nine months of 2021.
• Overall Impact: The report ruled out an alarming situation and said that with record high foreign reserves, there are no major risks to macro stability or balance of payments conditions.
  
  • However, the widening deficit trend may continue for some time as a combination of demand recovery and rising commodity prices will continue to widen the trade deficit sharply.

Balance of Payments

• Definition:
  
  • Balance of Payments (BoP) of a country can be defined as a systematic statement of all economic transactions of a country with the rest of the world during a specific period usually one year.
• Purposes of Calculation of BoP:
  
  • Reveals the financial and economic status of a country.
  • Can be used as an indicator to determine whether the country’s currency value is appreciating or depreciating.
  • Helps the Government to decide on fiscal and trade policies.
  • Provides important information to analyze and understand the economic dealings of a country with other countries.
• Components of BoP:
  
  • For preparing BoP accounts, economic transactions between a country and the rest of the world are grouped under - Current account, Capital account and Errors and Omissions. It also shows changes in Foreign Exchange Reserves.
  • Current Account: It shows export and import of visibles (also called merchandise or goods - represent trade balance) and invisibles (also called non-merchandise).
    
    • Invisibles include services, transfers and income.
  • Capital Account: It shows a capital expenditure and income for a country.
    
    • It gives a summary of the net flow of both private and public investment into an economy.
    • External Commercial Borrowing (ECB), Foreign Direct Investment, Foreign Portfolio Investment, etc form a part of capital account.
  • Errors and Omissions: Sometimes the balance of payments does not balance. This imbalance is shown in the BoP as errors and omissions. It reflects the country’s inability to record all international transactions accurately.
  • Changes in Foreign Exchange Reserves: Movements in the reserves comprises changes in the foreign currency assets held by the Reserve Bank of India (RBI) and also in Special Drawing Rights (SDR) balances.
  • Overall the BoP account can be a surplus or a deficit. If there is a deficit then it can be bridged by taking money from the Foreign Exchange (Forex) Account.
    
    • If the reserves in the forex account are falling short then this scenario is referred to as BoP crisis.

Source: TH