What is the issue?
- RBI's preliminary data on India's balance of payments (BoP) for July-September 2018-19 was released recently.
- It highlights the damage caused by high global oil prices and thus calls for appropriate policy response from the government.
What is the CAD state?
- Current Account Deficit (CAD) is the difference between outflow and inflow of foreign exchange in the country's current account.
- India’s CAD widened to 2.9% of gross domestic product (GDP) in the July-September quarter, a four-year high.
- This is in contrast to the same quarter a year ago when the CAD was only 1.1% of GDP.
- The widening of the CAD was due to an increase in the trade deficit.
- Trade deficit jumped to $50 billion in the September quarter as compared to $32.5 billion a year ago.
- This is due to a higher import bill, largely under the increasing pressure from the oil bill.
Is it a cause for concern?
- The major factor that was behind the Current Account Deficit phenomenon is the global oil prices.
- This has declined now as the global oil prices have dropped sharply since early October.
- Brent crude is down almost 30% from the high it reached in early October.
- The size of the deficit is thus likely to come down in the quarter ending December.
- So, the government may not be too worried about the widening CAD figures.
What is the need for caution?
- Despite the above, as usual, medium to long-term risks to the external sector remain, with widening CAD.
- There is the threat of price volatility faced by heavy importers of oil, a perennial threat to economic stability.
- India, thus, has to diversify its energy base by tapping into local sources of energy.
- Inflows - As long as foreign capital inflows into the economy are brisk enough to fund the huge import needs, widening CAD is not a worry.
- But the trouble arises when foreign inflows dry up and restrict the ability to purchase essential imports.
- So as liquidity conditions continue to tighten across the world, India’s heavy import dependence is a cause for concern.
- Also, if Western central banks tighten their monetary policy, the RBI will be forced to tighten its own policy stance.
- On the one hand, this would be essential to retain investment capital and defend the rupee.
- But on the other, this will impact domestic economic growth negatively.
What should be done?
- Each time the external account has come under pressure, the government has simply tried to bring in piecemeal emergency measures.
- These include a little opening up of the capital account or restrictions on imports.
- But such a policy is less likely to bring a permanent solution to the problem.
- In order to bring about any meaningful change, the government should also try implementing proper structural reforms.
- This would boost exports and help fund imports through means other than capital inflows, and end the over-reliance on imported oil.
Source: The Hindu
