What is the Current Account Deficit ?
- Current account deficit is simply the difference between the value of the goods and services that a country imports and the value of the products it exports.
- It encompasses the trade deficit plus capital like net income and transfer payments. In other words, it can be measured with the difference between foreign exchange inflows and outflows.
Why in the news?
- India’s current account deficit widened to 4.4 per cent of the GDP (USD 36.4 billion) in the quarter that ended September, from 2.2 per cent GDP during the April-June period, due to higher trade gap, as per data released by the Reserve Bank.
Reasons for increasing current account deficit
- Increased demand for imported products in India (increased imports)
- Decline in demand for Indian products abroad (decreased exports)
Managing Current account deficit- Possibilities
- An economy manages its current account deficit by foreign savings/foreign capital inflows. However that doesn’t seem feasible as the world is facing high levels of uncertainty that can be inferred from various instances like
- A land war in Europe
- the highest inflation in the developed world in the last four decades,
- the fastest pace of interest rate hikes in the history of the US Federal Reserve,
- an energy crisis in Europe, and
- a slowdown in China that continues to struggle with Covid-19.
- In such an uncertain situation along with the persistent rate hikes by the Fed foreign investors prefer to invest in safe assets such as US government bonds rather than emerging markets like India. As a result, India has witnessed large outflows of foreign capital in 2022-23.
- If India cannot attract the required amount of capital inflows, the RBI’s foreign exchange reserves could be deployed to pay for imports, however this strategy is neither appropriate nor sustainable.
- Allowing the rupee to depreciate
- Exporting becomes more profitable, inducing more and more firms to explore foreign markets.
- Foreign demand improves, because the rupee depreciation makes India’s products more price-competitive.
- As a result, exports increase and the CAD falls.
- It can sustain growth.
- Encourage foreign firms to produce in India by letting them access their supply chains
- Levying stiff import duties hampers exports and hence it has to be overcome by providing subsidies to a selected few producers.
- Encourage domestic firms to step up to the competition, and
- Creating a level playing field for all players is needed.
- A fundamental shift in India’s economic strategy.
- Policy needs to become significantly more export-oriented and less protectionist.
- By adopting this strategy, India could potentially solve its two most important macroeconomic problems — reducing the large CAD and securing rapid, sustained growth.