Time for caution: 

Time for caution: 

Context

Last week, the current account deficit (CAD) widened to a four-year high of $14.3 billion in the first quarter of the current financial year, standing at 2.4% of gross domestic product, compared to 0.1% last year.

Causes of widening Current Account Deficit

The widening CAD was driven by a  number of factors:

• Merchandise exports: One of the major reasons for the current deficit is the greater increase in merchandise imports than exports

• Increase import of Gold:Imports increased because of a rise in demand for gold(almost threefold) due to the upcoming festive season and tweaks in trade pacts with countries such as South Korea
• Services -Fall in exports of Services due to domestic industry issues and increased protectionism worldwide.
• Lower farm growth and government expenditure.
• The prolonged effects of demonetisation.
• Introduction of a new tax regime(Introduction of GST)

Causes of a Surplus in Capital Account

• Foreign investors starved of yield have been stepping up their investments in India, which remains one of the few places offering higher yields.
• Compared to last year, net FDI almost doubled in the first quarter, while net portfolio investment jumped about six times. The strong inflow of foreign capital has also led to a significant increase in foreign reserve holdings, thanks to the Reserve Bank of India which has been busy buying dollars to weaken the rupee,while the rupee has appreciated by over 6% against the dollar this year.
• Low global oil prices over the last two years have also helped contain a good portion of its import bills.

What could happen if the FED tightens it’s policy?

• All this might change with the impending tightening of monetary policy by the U.S. Federal Reserve and other central banks and the end of the era of easy money policy.
• Emerging Asian markets have been the biggest beneficiaries of loose monetary policy in the West, so any change in stance would most definitely affect them.
• Indian companies, for instance, have aggressively tapped into the market for rupee-denominated foreign debt, which can work against them if the flow of foreign capital turns volatile.

Way forward

• A strong capital account surplus,  has helped the country pay for its import bills without much trouble
• In addition, the imports of Gold need to be checked.  Tweaks in FTA’s  with foreign countries should be corrected to check illegal trade from third parties. The example of in the current scenario is that of the Illegal imports from South Korea that is not even amongst the world’s major producers or exporters of gold and related products.
• Effects of new tax regime should be carefully watched.
• Incentives to exporters and increase in budget expenditure to their interest.
• India should be prepared for the impending tightening of  monetary policy regime in U.S. and other countries as India has survived the current deficit on account of a strong capital account surplus.
• Also, India should seek to resolve the impending issues with other countries and organisations such as EU(regarding IPR regime and others) so that the India-EU FTA process could be hastened which could prove to be a major boon for services sector. Similarly, India’s push for a Services pact along with a goods pact in RCEP is a Step in the right direction.