The current account is a measurement of the flow of goods, services, and investments in and out of the country. A deficit implies a situation where imports exceed exports. A surplus is when the opposite is true.
How do we calculate CAD?
The current account includes net income, interest and dividends, and transfers such as foreign aid. Simply put,
Trade gap = Export (X) –Imports (M), and…
Current Account = Trade gap (X-M) + NY (Net income abroad) + NCT (Net current transfers)
A persistently widening CAD may imply that the economy is becoming uncompetitive, and therefore, foreign investors may lose interest in the economy and pull out investment causing a major devaluation of the domestic currency.
Thus, although depreciation of the currency boosts exports, the net effect of the depreciation on exports and imports is what will eventually steer the deficit numbers.
Factors affecting CAD
The current account is affected by several factors including the prevailing exchange rate, level of consumer spending, and hence, import spending, capital inflows, interest rate which also influences the level of import spending and finally, relative inflation/competitiveness.
For India, the value of the rupee as well as crude oil and gold imports are major factors which affect CAD.
Depreciation of the domestic unit against the dollar could fuel investors’ concerns regarding widening of the CAD given that this leads to more expensive inward-shipments/imports.
This may result in a vicious cycle as a huge current account gap could make the rupee depreciate further in the absence of a meaningful intervention from the central bank. All these factors could result in inflation for consumers and firms who depend on imports for raw materials.
Where does India stand currently?
The impact of CAD on the economy depends on the size of the CAD as a percentage of GDP. According to economists, a deficit of ~5% could be a cause for concern.
At present, India meets 70-80% of its requirements for oil and gold through inward shipments.
As per government data, India’s overall trade deficit for April-March FY18 is estimated at $87.17bn as compared to $ 47.7bn during April-March FY17, which could be attributed to rising costs of importing crude oil and gold.
India’s crude oil imports in April-January 2018-19 stood at $119.34bn (Rs8,34,763.84cr), which was 36.65% higher in dollar terms (48.45% in rupee terms) compared to $87.33bn (Rs562,321.87cr), over the same period, last year. This is because crude hit highs above $80/bbl in 2018.
However, the country’s gold imports dipped ~5% in value terms to $26.93bn during April-January 2018-19on the back of lower demand and a sharp price rally of the metal in the global market.
What the government can do to reduce CAD?
With general elections around the corner and the lull in equity markets, investors have turned their focus on the country’s CAD position. As per government data, the overall trade deficit for April-January 2018-19 is estimated at $90.58bn as compared to $75.73bn in April-January 2017-18.
In September 2018, the Reserve Bank of India (RBI) and Department of Economic Affairs had suggested measures to control widening CAD via the following measures:
- Mandatory currency hedging for infrastructure to be reviewed.
- Easier rules for manufacturing entities to raise funds overseas.
- Review of debt investment firms for FPIs.
- Removal of restriction on Indian banks’ market making of masala bonds.
- Exemption from withholding tax for masala bonds.
Masala Bonds are rupee-denominated borrowings introduced by the government in overseas markets. The objective of bonds is to fund infrastructure projects in India. With the removal of tax and restriction on masala bonds, the government would able to control CAD.
Moreover, the government also promises to boost exports and curb non-essential imports.
India’s CAD deteriorated to 1.9% of GDP in FY18 from 0.6% in the previous year. In the interim budget, the government of India has pegged CAD for FY19 at 2.5% of GDP.
Given the backdrop of several uncertainties on the global front, it seems that the demand for crude oil may remain subdued and keep prices in check. Yet, with the OPEC keeping its word on the supply cuts, it will really be a tough guess as to where CAD will go from here.