Why in news?
IMF recently forecasted India’s current account deficit (CAD) to widen to 2.6 percent of GDP in 2018/19 from 1.9 percent in the previous year.
What are the recent developments that affected CAD?
- Value of oil imports has risen, even though these have been offset by increases in net factor incomes from abroad.
- This lead to a balance between balance of trade and balance of invisibles in the current account.
- Stronger dollar growth and the negative events in Argentina and Turkey impacted many such emerging markets due to deteriorating emerging-market sentiment among investors.
What are the structural factors surrounding CAD in India?
- India’s GDP growth is largely driven by consumption that are largely import-intensive.
- A depreciating rupee should result in a fall in import demand and a rise in export demand through the price effect.
- The situation gets different altogether in India, wherein exports respond mainly to improvements in productivity and to changes in global demand.
- This made our exports highly inelastic to exchange rate depreciation.
- Since 1991, import intensity of the Indian economy has risen steadily.
- It has been fuelled by increased elite prosperity and their luxury consumption needs instead of importing food and other items of mass consumption.
- Key growing sectors like defence, aviation, and electronics have failed to secure significant import substitution in recent times.
- New import-intensive sectors have emerged as in cheap clothing from Bangladesh and Vietnam and solar panels from Japan and China.
- India also raised its import of non-tradeables wherein forex spent on education and recreational travel abroad raised from $176 million in 2013 to $5.4 billion in 2017.
What does the recent Nomura Damocles Index say?
- It assesses the risk of exchange rate crisis for 30 emerging market economies.
- A score above 100 suggests a country is vulnerable to an exchange rate crisis in the next 12 months.
- With moderation in CPI inflation and the CAD, alongside sufficient forex reserve buffer, India scored 25 and was well within the safety threshold.
- Yet, higher oil prices, portfolio outflows and a sharper-than-expected domestic growth slowdown still remains as its key vulnerabilities.
How should India proceed?
- Encouraging FDI and FPI inflows could be the immediate strategy to arrest the rising CAD.
- That would make CAD to stabilise at levels which our growing mega-economy would easily finance by attracting stable capital inflows.
- But in the long term, India should moderate the CAD by orienting her domestically driven growth to foster substitution in imports.
- Hence, India’s external account challenge is structural and it requires a continuing, orderly depreciation of the rupee, which would eventually reduce the pace of import growth and encourage export growth.
Source: Business Standard