Widening of Current Account Deficit

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