Economy Decoded

India’s Current Account Deficit- Decoded

By | 10 Feb, 2013 5:36 PM |

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SHARES
Since the reforms of 1991, India’s share in the total world trade has increased rapidlyIndia accounts for 1.44% of exports and 2.12% of imports for merchandise trade and 3.34% of exports and 3.31% of imports for commercial services trade worldwide. 

Until recently it has been able to maintain a favorable balance of payment position. Though the current account of BOP has consistently been in deficit since 2005-06, it was offset by the surplus in capital account(foreign capital inflows). However since the last few years current account deficit has widened sharply. In 2011-12, CAD was 4.2% of GDP. This deficit has led to sharp pressures on BOP.

Although exports increased after liberalization, the rise in imports was more than the rise in exports. Oil constitutes the major and essential proportion of our import bill.  Imports of non-oil products especially gold have also increased due to persistent inflation (absence of such financial instruments in India which can act as a hedge against inflation has led to rise in gold investment).This has contributed to a huge current account deficit. Due to slow GDP growth rate, the capital inflows to India have also slowed down.

The solutions to our BOP problems:-

  • We have to boost investors confidence by making our policy environment more predictable. Increase in FDI limit in multi-brand retail(51%) and aviation(49%) is a step in the right direction.
  • To be able to pay for our imports we will have to save more and focus on fiscal consolidation. Increase in the price of diesel will not only reduce the burden of subsidies on the govt. but also discourage excessive consumption and hence reduce our oil import bill.
  • We have to push our exports and diversify across markets(such as Asia and Africa). This will make our economy resilient to slowdown in the world economy.
  • To increase our export competitiveness in the long run ,we will have to reduce cost by improving domestic infrastructure.
  • We also have to reduce our dependence on oil imports through more oil and gas explorations in the country.
  • Imposing customs duty on gold will only lead to black-marketing. We will have to manage inflation through monetory and fiscal policy.
Many countries devalue their currency to boost their exports(It makes exports cheaper and imports costlier). But India will have to steer clear of such policies. We have already witnessed that rupee depreciation in the recent past did not improve our CAD. It was because of the fact that our imports are price inelastic. Oil will be imported to meet our energy and infrastructure needs no matter what the price. Moreover some imports are used as inputs in the products which are exported, hence making devaluation ineffective.

The Government of India has to take steps to increase the confidence of investors in our economy. It will have to take tough ‘anti-populist’ measures to diffuse the prevailing sentiment of  gloom and policy-paralysis in the environment. This will revive our growth and increase foreign capital inflows and help make our BOP deficits sustainable.

Views presented in the article are those of the author and not of ED.

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