Current Account Deficit

• 11 Mar 2022

For Prelims: Current Account Deficit, Balance of Payments, Forex Reserve.

For Mains: Factors on which Current Account Deficit depends and measures to deal with it.

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.

PYQ

Consider the following actions which the Government can take: (2011)

1. Devaluing the domestic currency.
2. Reduction in the export subsidy.
3. Adopting suitable policies which attract greater FDI and more funds from FIIs.

Which of the above action/actions can help in reducing the current account deficit?

(a) 1 and 2
(b) 2 and 3
(c) 3 only
(d) 1 and 3

Ans: (d)

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.

PYQ

With reference to Balance of Payments, which of the following constitutes/constitute the Current Account? (2014)

1. Balance of trade
2. Foreign assets
3. Balance of invisibles
4. Special Drawing Rights

Select the correct answer using the code given below:

(a) 1 only
(b) 2 and 3
(c) 1 and 3
(d) 1, 2 and 4

Ans: (c)

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.

PYQ

Which of the following constitute a Capital Account? (2013)

1. Foreign Loans
2. Foreign Direct Investment
3. Private Remittances
4. Portfolio Investment

Select the correct answer using the codes given below:

(a) 1, 2 and 3
(b) 1, 2 and 4
(c) 2, 3 and 4
(d) 1, 3 and 4

Ans: (b)

Source: TH