Challenges in current account deficit

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