- Reducing CAD is of immediate concern: RBI
- India’s current account deficit set to worsen again in Q2 2013, says Nomura
- High current account deficit a matter of concern: Subbarao (Governor, RBI)
- Current account deficit likely to be at 4% in Q4 FY13: Rajan (Chief Economic Advisor, Government of India)
- RBI and Government Target Gold to Lower Current Account Deficit -NASDAQ
Now, let us understand the importance and impact of the current account deficit.
SECTION I - CURRENT ACCOUNT DEFICIT- CONCEPT
SECTION II - THE BALANCE OF PAYMENTS - CONCEPT AND COMPONENTS
SECTION III - BALANCE OF PAYMENTS- THEORY -OPEN ECONOMY MACROECONOMICS
SECTION IV - INDIA – POLICY AND PRACTICE
SECTION V – ANALYSIS OF TRENDS IN INDIA- RESEARCH INPUTS FROM EXPERTS
SECTION I - CURRENT ACCOUNT DEFICIT- CONCEPT
Current account deficit (CAD) has been the most discussed issue everywhere nowadays. This article looks into the basics of CAD, what constitutes the CAD, the causes of CAD and its impact. In order to understand CAD we need to understand what do we mean by current account since the issue of current account deficit originates from current account component of the balance of payments of a nation. This further necessitates the need to understanding of the concept of balance of payment (BOP) and open economy. Needless to say the foundation of the above discussions lies in the emergence of global trade in this century since with the interdependence of nations across the globe any nation facing BOP and CAD crisis faces lot of challenges in terms of its currency value, hurdles in its foreign investment , global competitiveness and hence overall economic growth.
Keeping in mind this article is structured in the following format. At the outset it discusses the issue of CAD, its importance, causes and its impact. Then it explains the concept current account which is a broader term, here we come to know about the various components of current account and this enables us to understand id detail the issue of CAD. Further, the article in the next stage gives the reader a broader comprehensive view of the concept of balance of payment. Here we explain the two broad components of the BOP namely the current account (in detail) and the capital account (brief). Further, the article goes on to explain in brief, the current trends in CAD in India, the policy and practice of computing current account in India and summary of some of the research inputs by expert economists on this topic.
Current Account Deficit
Current account deficit is when payments exceed receipts from trade of goods & services, transfers and net income.
It indicates a country (say India) is borrowing and is net debtor to rest of the world. A current account deficit is when a country's government, businesses and individuals import more goods, services and capital than it exports. That's because the current account measures trade, as well as international income, direct transfers of capital, and investment income made on assets. When those within the country rely on foreigners for the capital to invest and spend, that creates a current account deficit. Depending on why the country is running the deficit, it could be a positive sign of growth, or it could be a negative sign that the country is a credit risk.
The largest component of a deficit usually a trade deficit. Increasing trade deficit on account of higher imports is the major component leading to increase of current account deficit.
This simply means the country imports more goods and services than it exports. The second largest component is usually a deficit in the net income. This occurs when the country exports dividends on stocks, interest payments made on financial assets, and wages paid to foreigners working in the country. If all payments made to foreigners are greater than the interest, dividends and wages made by foreigners to the country's residents, the deficit will rise.
The last component of the deficit is the smallest, but often the most hotly contested. These are direct transfers, which includes government grants to foreigners. It also includes any money sent back to their home countries by foreigners.
Now, let us understand the Consequences of the Current Account Deficit.
Consequences of the Current Account Deficit
A deficit in the current account leads to depletion of foreign currency assets as these assets are used as a source to fund deficit which forms part of capital account. Depletion of foreign currency assets reduces money supply which in turn results to liquidity issues. High imports results in higher demand for dollar causing rupee to weaken (rupee depreciation) which in turn impacts liquidity.
In the long run, a current account deficit can sap economic vitality. Foreign investors may begin to question whether economic growth can provide an adequate return on their investment. Demand could weaken for the country's assets, including the country's government bonds. As this happens, the national currency will gradually lose value relative to other currencies. This automatically lowers the value of the assets in the foreign investors' currency. This further depresses the demand for the country's assets. This could lead to investors will dumping the assets at any price. The only saving grace is that the country's holdings of foreign assets are denominated in foreign currency. As the value of its currency declines, the value of the foreign assets rise, thus further reducing the current account deficit. In addition, a lower currency value should increase exports, as the goods and services become more competitively priced. Similarly, demand for imports should lessen, as inflation on foreign goods and services sets in. These trends should stabilize any current account deficit. Regardless of whether the current account deficit unwound via a disastrous currency crash or a slow, controlled decline, the consequences of a current account deficit would be the same -- a lower standard of living for the country's residents.
-- Prof. M. Guruprasad,
AICAR BUSINESS SCHOOL