Current Account Deficit | 11 Mar 2022

Why in News?

Recently, an American financial services company Morgan Stanley has predicted that the Current Account Deficit will widen to a 10-year high of 3% of GDP in FY23.

What are the Key Points?

• In the wake of continued geopolitical tensions, the surge in oil prices is likely to be sustained, which would lead to deterioration in the current account deficit from a higher oil import bill.
• The Balance of Payments (BoP) to be in deficit of approximately 0.5-1% of GDP (Gross Domestic Product) because capital flows are likely to be lower than the current account deficit.
• The extent of vulnerability to funding risks will be cushioned by the large forex reserves, which stand at USD 681 billion.
• The company expects the April 2022 policy to mark the process of policy normalization with a reverse repo rate hike. However, if the RBI were to delay its normalization process, the risk of disruptive policy rate hikes would rise.
• There is less room for fiscal policy stimulus to support growth given high deficit and debt levels – it is seen that there is a possibility of a modest fuel tax cut and reliance on the national rural employment program as an automatic stabilizer.

What is the Current Account Deficit?

• A current account deficit occurs when the total value of goods and services a country imports exceeds the total value of goods and services it exports.
  • The balance of exports and imports of goods is referred to as the trade balance. Trade Balance is a part of ‘Current Account Balance’.
• According to an earlier report of 2021, High Oil Imports, High Gold Imports are the major driving force, widening the CAD.

What is Balance of Payments?

• About:
  • BoP of a country can be defined as a systematic statement of all economic transactions of a country with the rest of the world during a specific period, usually one year.
• Purposes of Calculation of BoP:
  • Reveals the financial and economic status of a country.
  • Can be used as an indicator to determine whether the country’s currency value is appreciating or depreciating.
  • Helps the Government to decide on fiscal and trade policies.
  • Provides important information to analyze and understand the economic dealings of a country with other countries.
• Components of BoP:
  • For preparing BoP accounts, economic transactions between a country and the rest of the world are grouped under - Current account, Capital account and Errors and Omissions. It also shows changes in Foreign Exchange Reserves.
  • Current Account: It shows export and import of visibles (also called merchandise or goods - represent trade balance) and invisibles (also called non-merchandise).
    • Invisibles include services, transfers and income.
  • Capital Account: It shows a capital expenditure and income for a country.
    • It gives a summary of the net flow of both private and public investment into an economy.
    • External Commercial Borrowing (ECB), Foreign Direct Investment, Foreign Portfolio Investment, etc form a part of capital account.
  • Errors and Omissions: Sometimes the balance of payments does not balance. This imbalance is shown in the BoP as errors and omissions. It reflects the country’s inability to record all international transactions accurately.
  • Changes in Foreign Exchange Reserves: Movements in the reserves comprises changes in the foreign currency assets held by the Reserve Bank of India (RBI) and also in Special Drawing Rights (SDR)balances.
  • Overall the BoP account can be a surplus or a deficit. If there is a deficit then it can be bridged by taking money from the Foreign Exchange (Forex) Account.
    • If the reserves in the forex account are falling short then this scenario is referred to as BoP crisis.

Source: TH