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Challenges in current account deficit

September 14, 2018
12 days

Why in news?

IMF recently forecasted India’s current account deficit (CAD) to widen to 2.6 percent of GDP in 2018/19 from 1.9 percent in the previous year.

What are the recent developments that affected CAD?

  • Value of oil imports has risen, even though these have been offset by increases in net factor incomes from abroad.
  • This lead to a balance between balance of trade and balance of invisibles in the current account.
  • Stronger dollar growth and the negative events in Argentina and Turkey impacted many such emerging markets due to deteriorating emerging-market sentiment among investors.

What are the structural factors surrounding CAD in India?

  • India’s GDP growth is largely driven by consumption that are largely import-intensive.
  • A depreciating rupee should result in a fall in import demand and a rise in export demand through the price effect.
  • The situation gets different altogether in India, wherein exports respond mainly to improvements in productivity and to changes in global demand.
  • This made our exports highly inelastic to exchange rate depreciation.
  • Since 1991, import intensity of the Indian economy has risen steadily.
  • It has been fuelled by increased elite prosperity and their luxury consumption needs instead of importing food and other items of mass consumption.
  • Key growing sectors like defence, aviation, and electronics have failed to secure significant import substitution in recent times.
  • New import-intensive sectors have emerged as in cheap clothing from Bangladesh and Vietnam and solar panels from Japan and China.
  • India also raised its import of non-tradeables wherein forex spent on education and recreational travel abroad raised from $176 million in 2013 to $5.4 billion in 2017.

What does the recent Nomura Damocles Index say?

  • It assesses the risk of exchange rate crisis for 30 emerging market economies.
  • A score above 100 suggests a country is vulnerable to an exchange rate crisis in the next 12 months.
  • With moderation in CPI inflation and the CAD, alongside sufficient forex reserve buffer, India scored 25 and was well within the safety threshold.
  • Yet, higher oil prices, portfolio outflows and a sharper-than-expected domestic growth slowdown still remains as its key vulnerabilities.

How should India proceed?

  • Encouraging FDI and FPI inflows could be the immediate strategy to arrest the rising CAD.
  • That would make CAD to stabilise at levels which our growing mega-economy would easily finance by attracting stable capital inflows.
  • But in the long term, India should moderate the CAD by orienting her domestically driven growth to foster substitution in imports.
  • Hence, India’s external account challenge is structural and it requires a continuing, orderly depreciation of the rupee, which would eventually reduce the pace of import growth and encourage export growth.

Source: Business Standard





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