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Current Account
Deficit
' 11th March, 2022 ( Economy

Disclaimer: Copyright infringement not

intended.

Context:

Morgan Stanley has cut India’s GDP

growth estimate by 50 basis points to 7.9
per cent and raised the retail (CPI) inflation
forecast to 6 per cent.
It also expects the current account deficit
to widen to a 10-year high of 3 per cent of
GDP in FY23.

Current Account Deficit:

Current Account Deficit or CAD is the

shortfall between the money flowing in
on exports, and the money flowing out
on imports.
Current Account Deficit (or Surplus)
measures the gap between the money
received into and sent out of the country
on the trade of goods and services and
also the transfer of money from
domestically-owned factors of production
abroad.

Calculating Current Account Deficit:

The current account constitutes net

income, interest and dividends and
transfers such as foreign aid, remittances,
donations among others. Although these
components make up only a small
percentage of the total current account.

The current account represents a country’s

foreign transactions and, like the capital
account, is a component of a country’s
balance of payments (BOP).

Current Account Deficit is measured as a

percentage of GDP.
1. Trade gap = Exports – Imports
2. Current Account = Trade gap + Net current
transfers + Net income abroad

A country with rising CAD shows that it

has become uncompetitive, and investors
are not willing to invest there. They may
withdraw their investments.

NOTE: CAD vs Trade Deficit

The terms current account deficit and trade

deficit are often used interchangeably, but
they have substantially different meanings.

Current Account Deficit is slightly different

from Balance of Trade, which measures
only the gap in earnings and expenditure
on exports and imports of just 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
Current Account, but not in Balance of
Trade.

A nation has a trade deficit when it spends

more on imports than it earns on exports.
A nation's current account deficit is a
broader measure. The trade deficit is
almost always the largest component of
the current account deficit but it includes
other numbers such as foreign aid and
international investment.
It is, in fact, possible for a nation to have a
current account deficit when it does not
have a trade deficit, but that is highly
unusual.

Is Current Account Deficit always a

negative indicator?

Current Account Deficit 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.
Current Account Deficit 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.

A current account deficit is not necessarily

harmful:

A current account deficit could occur

during a period of inward investment
(surplus on financial account).
This inward investment can create jobs
and investment. E.g. the US ran a current
account deficit for a long time as it
borrowed to invest in its economy. This
enabled higher growth and so it was able
to pay its debts back and countries had
confidence in lending the US money.
With a floating exchange rate, a large
current account deficit should cause a
devaluation which will help automatically
reduce the level of the deficit.
A current account deficit may just indicate
a strong economy, which is growing
rapidly. For example, the rise in deficit on
UK primary incomes (2015-16) is a
reflection that investment in the UK was
giving a good return to foreign investors.

Further Evaluation:

It depends on the size of the current

account deficit as a % of GDP. For
example, a deficit of over 5% would be
cause for greater concern.
It depends on how one is financing the
current account deficit. If a country is
borrowing from abroad to finance
consumption, this is damaging in the
long-term. If it is financing the current
account deficit through attracting long-
term capital investment, this could have
positive benefits.
It depends on the country in question. For
example, the US probably has less reason
to be concerned about a current account
deficit. The US can attract a lot of capital
flows to buy dollar securities. However, a
developing economy like India may be
more vulnerable to a current account
deficit. This is because investors may be
quicker to fear an economic downturn and
remove their capital.

Dealing with Current Account Deficit?

CAD exists due to a host of factors

including existing exchange rate, consumer
spending level, capital inflow, inflation
level, and prevailing interest rate.
For the Current Account Deficit in India,
crude oil and gold imports are the
primary reasons behind high CAD.
The Current Account Deficit could be
reduced by boosting exports and curbing
non-essential imports such as gold,
mobiles, and electronics.
Currency hedging and bringing easier rules
for manufacturing entities to raise foreign
funds could also help.
The government and RBI could also look to
review debt investment limits for FPIs,
among other measures.

Recent Findings of Morgan and Stanley:

In the wake of continued geopolitical

tensions (Ukraine Russia-War), the surge
in oil prices is likely to be sustained, which
would lead to deterioration in the current
account deficit from a higher oil import bill.
The risk would stem from a further
sustained rise in oil prices, leading to quick
deterioration in macro stability and
currency volatility.
Analysis shows that a 10 per cent rise in
oil prices would widen India’s current
account deficit by 30-35 bps of GDP.
Further, the balance of payments could be
in deficit of approximately 0.5-1 per cent of
GDP because capital flows are likely to be
lower than the current account deficit.

Suggestions made:

The extent of vulnerability to funding risks

will be cushioned by the large forex
reserves, which along with forward book
stand at $681 billion.
Morgan Stanley expects policy
normalization with a reverse repo rate
hike. However, if the RBI were to delay its
normalization process, the risk of
disruptive policy rate hikes would rise.
There is less room for fiscal policy stimulus

 to support growth given high deficit and

debt levels.
A possibility of a modest fuel tax cut and
reliance on the national rural
employment program could be an
automatic stabilizer.

Important links:

https://www.iasgyan.in/blogs/key-economic-
concepts-back-to-basics

https://www.iasgyan.in/blogs/inflation-all-
you-need-to-know

https://www.iasgyan.in/daily-current-
affairs/monetary-policy

https://www.iasgyan.in/blogs/budget-basics-
key-financial-terms-you-need-to-know

https://indianexpress.com/article/business/economy
account-deficit-likely-to-hit-10-year-high-
7814251/

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