Widening Current Account Deficit

Why in news?

A recent data has revealed that India’s Current Account Deficit (CAD) has widened to 2.4 % of GDP in the first quarter of 2017-18, which is the highest in the last four years.

What is CAD?

• CAD refers to the deficit arising out of the difference between inflow and outflow of foreign exchange as a result of imports and exports.
• CAD stood at $14.3 billion in the first quarter of the current financial year.
• This was valued at 2.4% of gross domestic product, compared to 0.1% last year.

What are the reasons for its increase?   

• Trade - Imports overall rose by over 20% year-on-year in August.
• On the other hand, exports rose by only 10% in the same period.
• The resultant higher trade deficit has translated into higher CAD.
• Half of the rise in this import is contributed by the spike in gold imports prior to the introduction of GST.
• Exchange Rate - Rupee has appreciated by over 6% against the dollar this year.
• An over-valued currency has resulted in reduced margins and made exports uncompetitive; thus an imbalance in trade in favour of imports.

How did India manage inspite of higher CAD? 

• Capital Account Surplus - India was able to pay its import bills easily due to a strong capital account surplus.
• Foreign investors have pumped huge sums into India as it remains one of the few places offering higher yields.
• Net FDI almost doubled in the first quarter this year.
• Also, net FPI jumped about six times to $12.5 billion.
• External Debt - India’s total external debt also declined by 2.7% during the financial year 2016-17.
• However, this is not a sustainable solution to the problem.

What are the risks of this trend?

• A large CAD to GDP is viewed as making a country more vulnerable to sudden stops or reversals in foreign capital inflows.
• There are signs that the U.S.Federal reserves & some other western central banks are considering a monetary policy tightening.
• This will impact the foreign investment flows to India. 
• This might also push the Rupee into a downward spiral.

What should be done?

• The imbalance in trade is now to be resolved by boosting exports.
• The blockage of funds under GST and uncertainties has left little or no working capital at the disposal of exporters.
• Focussing on manufacturing in the labour-intensive sectors would bring the double benefits of boosting exports and generating employment.
• Efforts are needed to reduce paperwork and costly over-regulation so as to make exporting easier.
• Besides, RBI should keep a check on the external commercial borrowings to keep debt under control.

Source: Business Standard