India’s Current Account Deficit

Source – This post on India’s Current Account Deficit has been created based on the article “India’s small current account deficit has a flip side to it” published in “Live Mint” on 12 August 2024.

UPSC Syllabus – GS Paper 3 – Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment

Context – India’s Current Account Deficit (CAD) has fallen from nearly 5% of GDP in 2012-13 to around 1% in recent years. A CAD of 2-2.5% of GDP is considered sustainable, ensuring that India’s external stability remains intact and net external liabilities stay stable relative to GDP. Since the current CAD is almost 1 percentage point lower than the sustainable level, India is missing out on the chance to boost investment rates.

Recent trends indicate that firms are mainly responsible for the investment gap. Although companies have shifted from borrowing to saving over the past decade, they are still not investing enough. This lack of investment may be due to changes in the economy, like the rise of the services sector, and other economic factors.

What are Structural and Cyclical Factors Affecting Investment?

1) Rise of the Services Sector- Over the past decade, India’s nominal GDP has grown by about $1.7 trillion, with 52% of this growth coming from the services sector, compared to just 11% from manufacturing. Since the services sector requires less capital investment, this has lowered the overall capital intensity of India’s growth.

Read More- Challenges and Opportunities in Indian Economy

2) Weak Backward Linkages– A strong services sector often leads to concentrated economic benefits but has weak ties with other industries. For every dollar earned in services, only 30 cents comes from inputs supplied by other sectors. In comparison, manufacturing uses 73 cents of inputs from other sectors for each dollar of output.

3) Challenges in the Manufacturing Sector– The manufacturing sector is struggling due to excessive foreign competition and excess capacity. For instance, in industries like leather and apparel, production is more than 20% below pre-pandemic levels.

4) Trade Deficit with China– India’s trade deficit with China has grown to about $100 billion, with $40 billion of that increase occurring in the last three years. The drop in the yuan’s value has made Chinese goods cheaper, especially in low-tech areas. This has increased competition and put more pressure on India’s manufacturing sector.

Conclusion– India’s low business capital spending is due to complex demand issues, resulting in a current account deficit much lower than sustainable levels. Although there is no easy fix, increasing investment is important.

Question for practice

What are Structural and Cyclical Factors Affecting Investment?