Syllabus: GS3/Economy
Context
- India seems headed for a third consecutive year of a balance-of-payments deficit with the rest of the world.
About Current Account Deficit (CAD)
- Current Account records transactions of goods, services, income, and transfers between a country and the rest of the world, and its deficit occurs when a country’s total imports of goods, services, and transfers exceed its exports.
- CAD is if total outflows is more than inflows.
- It reflects the external imbalance and indicates that the country is a net borrower from the rest of the world.
- Components of Current Account:
- Trade Balance (Exports – Imports of goods)
- Services (IT, tourism, etc.)
- Income (interest, dividends)
- Transfers (remittances)
Recent Trends in India’s CAD
- IMF projects India’s CAD at $84.46 billion, one of the highest in two decades.
- Comparable to the 2012 crisis period (~$87.84 billion).
- India may face a third consecutive Balance of Payments (BoP) deficit.
- CAD is driven by external factors (oil prices), not domestic instability.
Reasons for Widening CAD in India
- Rising Crude Oil Prices: It is a major driver of CAD increase. India imports nearly 85% of its crude, leading to higher import bill and wider trade deficit.
- Oil price assumptions increased to $82–85/barrel (IMF & RBI estimates)
- High Import Dependence: Imports of energy (oil, gas), gold, and electronics. Rapid economic growth increases demand for imports faster than exports.
- Slower Export Growth: Global slowdown reduces demand for Indian exports. Structural issues like low manufacturing competitiveness, and dependence on limited export sectors.
- Weak Capital Inflows: CAD needs financing via Foreign Direct Investment (FDI); Portfolio flows (FPI); and External borrowings.
- Global uncertainty leading to investors becoming risk-averse and lower inflows of capital.
- Global Economic Uncertainty: Geopolitical tensions, inflation, and monetary tightening in advanced economies reduce trade demand, and capital flows.
- Currency Depreciation: Rupee depreciation increases cost of imports (especially oil), leading to worsening trade deficit and CAD.
- Growth-Import Link: According to Thirlwall’s Law, faster GDP growth leads to higher imports. CAD widens, if exports don’t grow equally.
What is CAD Sustainability?
- CAD-to-GDP Ratio: Earlier threshold (Rangarajan Committee, 1993): 1.6% of GDP
- Current consensus: 2–2.5% of GDP is sustainable
- India’s CAD projected around 2% of GDP which is within manageable limits. CAD-to-GDP ratio still within sustainable range.
- Inter-temporal Borrowing: CAD is sustainable if borrowed funds today lead to future growth and repayment capacity.
- Net Foreign Liabilities: Sustainability depends on maintaining a stable external debt-to-GDP ratio.
- Adjustment Risks: Unsustainable CAD may lead to sharp currency depreciation, high interest rates, and economic slowdown.
Policy Measures & Way Forward
- Short-Term:
- Diversify energy imports and promote strategic reserves
- Encourage stable capital inflows
- Manage exchange rate volatility
- Long-Term:
- Boost export competitiveness (PLI schemes, manufacturing push)
- Reduce import dependence (especially energy)
- Strengthen services exports (IT, digital economy)
Conclusion
- India’s widening CAD reflects global shocks more than domestic weakness.
- Sustained external imbalances could constrain growth unless export performance improves and import dependence reduces, while current levels remain manageable.
| Daily Mains Practice Question [Q] Discuss the causes of the rising Current Account Deficit (CAD) in India and examine its sustainability. Suggest policy measures to manage external sector vulnerabilities. |
