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Widening of Current Account Deficit

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December 10, 2018

What is the issue?

  • RBI's preliminary data on India's balance of payments (BoP) for July-September 2018-19 was released recently.
  • It highlights the damage caused by high global oil prices and thus calls for appropriate policy response from the government.

What is the CAD state?

  • Current Account Deficit (CAD) is the difference between outflow and inflow of foreign exchange in the country's current account.
  • India’s CAD widened to 2.9% of gross domestic product (GDP) in the July-September quarter, a four-year high.
  • This is in contrast to the same quarter a year ago when the CAD was only 1.1% of GDP.
  • The widening of the CAD was due to an increase in the trade deficit.
  • Trade deficit jumped to $50 billion in the September quarter as compared to $32.5 billion a year ago.
  • This is due to a higher import bill, largely under the increasing pressure from the oil bill.

Is it a cause for concern?

  • The major factor that was behind the Current Account Deficit phenomenon is the global oil prices.
  • This has declined now as the global oil prices have dropped sharply since early October.
  • Brent crude is down almost 30% from the high it reached in early October.
  • The size of the deficit is thus likely to come down in the quarter ending December.
  • So, the government may not be too worried about the widening CAD figures.

What is the need for caution?

  • Despite the above, as usual, medium to long-term risks to the external sector remain, with widening CAD.
  • There is the threat of price volatility faced by heavy importers of oil, a perennial threat to economic stability.
  • India, thus, has to diversify its energy base by tapping into local sources of energy.
  • Inflows - As long as foreign capital inflows into the economy are brisk enough to fund the huge import needs, widening CAD is not a worry.
  • But the trouble arises when foreign inflows dry up and restrict the ability to purchase essential imports.
  • So as liquidity conditions continue to tighten across the world, India’s heavy import dependence is a cause for concern.
  • Also, if Western central banks tighten their monetary policy, the RBI will be forced to tighten its own policy stance.
  • On the one hand, this would be essential to retain investment capital and defend the rupee.
  • But on the other, this will impact domestic economic growth negatively.

What should be done?

  • Each time the external account has come under pressure, the government has simply tried to bring in piecemeal emergency measures.
  • These include a little opening up of the capital account or restrictions on imports.
  • But such a policy is less likely to bring a permanent solution to the problem.
  • In order to bring about any meaningful change, the government should also try implementing proper structural reforms.
  • This would boost exports and help fund imports through means other than capital inflows, and end the over-reliance on imported oil.

 

Source: The Hindu

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