Where is India’s current account deficit headed

Where is India’s current account deficit headed

News:

India’s current account deficit (CAD) widened to a four-year high of 2.9% of gross domestic product (GDP) in the July-September period, up from 2.4% in April-June this year.

Facts:

Current Account Deficit

• Current account measures the flow of goods, services and investments into and out of the country. We run into a deficit if the value of the goods and services we import exceeds the value of those we export.

Components

• The largest component of a current account deficit is the trade deficit. That’s when the country imports more goods and services than it exports.
• The second largest component is a deficit in net income. That’s when foreign investment income exceeds the savings of the country’s residents.
• Net income is measured by the following four things.
  • Payments made to foreigners in the form of dividends of domestic stocks.
  • Interest payments on bonds.
  • Wages paid to foreigners working in the country.
  • Direct transfers, mostly money foreign residents send back to their home countries. It also includes government grants to foreigners.

Why does CAD matter

• Current account balance measures the external strength or weakness of an economy.
• A current account surplus implies the country is a net lender to the rest of the world, while a deficit indicates it is a net borrower.

Why is CAD rising?

• Tensions in the Gulf region, US sanctions on Iran and the instability in key oil exporting nation Venezuela pushed global crude prices
• India being a net importer of crude oil, weakening rupee has made imports of crude oil costlier.
• The China-US trade war hampering export growth, while rising investment demand will lead to more imports. This may further widen CAD in FY19.

Consequences of High CAD

• In the short-run, a current account deficit is helpful to the debtor nation. Foreigners are willing to pump capital into it. That drives economic growth beyond what then country could manage on its own.
• The national currency loses value relative to other currencies. That lowers the value of the assets in the foreign investors’ strengthening currency.
• It further depresses investor demand for the country’s assets. This can lead to a tipping point where investors will dump the assets at any price (Foreign investors withdraw funds, bond yields rise)
• A higher CAD will put the rupee under pressure and may raise the cost of overseas borrowing.
• Depleting foreign exchange reserves could raise CAD further.

Why is a high CAD cause for concern for India?

• High CAD will be financed through a mix of foreign direct investment (FDI), portfolio flows and forex reserves management.
• While FDI flows rose in recent years, a strong dollar and tighter global financial conditions have put more pressure on portfolio investments. The net outflow of portfolio investments in Q2FY19 was $2.4 billion.
• Based on India’s historical cash flows and capital inflow curbs, global markets might not be able to finance a CAD above 3% of GDP, as per International Monetary Fund.