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Moderating Current Account Deficit (CAD)

Posted on February 17, 2023 by admin1  1049

In News

  • The recent data indicated that the current account deficit (CAD) will moderate despite the global slowdown triggered by rising inflation and interest rates.

About the recent trend of moderation

  • About:
    • According to the RBI, the CAD, which was at $36.4 billion for the quarter ending September 2022, is expected to moderate in the second half of 2022-23 and remain eminently manageable and within the parameters of viability. 
  • The moderation in CAD, expected to be aided by 
    • The fall in commodity prices, 
    • Rising worker’s remittances and services exports, and 
    • Abatement of selling pressure by foreign investors, is set to boost sentiment on the investment front, as it will also bring the pressure off the currency.

More about CAD

  • Meaning:
    • When the value of the goods and services that a country imports exceed the value of the products it exports, it is called the current account deficit. 
  • Twin deficits:
    • CAD and the fiscal deficit together make up the twin deficits – the enemies of the stock market and investors. 
  • Difference with the Balance of Trade:
    • It is slightly different from the Balance of Trade, which measures only the gap in earnings and expenditure on exports and imports of goods and services. 
    • Whereas, the current account also factors in the payments from domestic capital deployed overseas. 
      • For example, rental income from an Indian owning a house in the UK would be computed in the Current Account, but not in the Balance of Trade.
  • Significance:
    • If the current account – the country’s trade and transactions with other countries – shows surplus, that indicates money is flowing into the country, boosting the foreign exchange reserves and the value of rupee against the dollar. 
    • These are factors that will have ramifications on the economy and the stock markets as well as on returns on investments by people.
  • Indicator of Economy:
    • CAD may be a positive or negative indicator for an economy depending upon why it is running a deficit. 
      • Foreign capital is seen to have been used to finance investments in many economies. 
      • It may help a debtor nation in the short-term, but it may worry in the long-term as investors begin raising concerns over adequate return on their investments.
  • India’s position:
    • India’s current account position is largely on the deficit side because of the country’s dependence on oil imports. 
  • Ways of reducing CAD:
    • The Current Account Deficit can be reduced by boosting exports and curbing non-essential imports such as gold, mobiles, and electronics.

About the “Current Account”

  • A nation’s Current Account maintains a record of the country’s transactions with other nations. It comprises the following components:
    • trade of goods and services,
    • net earnings on overseas investments and net transfer of payments over a period of time, such as remittances
  • This account goes into a deficit when money sent outward exceeds that coming inward.
  • Calculation:
    • It is measured as a percentage of GDP.
      • Trade gap = Exports – Imports.
      • Current Account = Trade gap + Net current transfers + Net income abroad.

Reasons for narrowing trade deficit

  • The trade deficit (for Jan 2023) narrowed to $17.7 billion, led by a sharp fall in imports, while exports fell by a smaller amount. 
  • The sharp drop in imports was due to: 
    • Non-oil imports falling, mainly due to a price impact (softening in coal prices from mid-December), 
    • Likely softening in domestic demand post the festive season (such as lower imports of transport equipment), and 
    • Seasonal impact of the Chinese New Year holidays
  • Other factors:
    • On the other hand, after the Rs26,000 crore sell-off by foreign portfolio investors in January, FPI outflows have come down to Rs4,400 crore in February so far. 
    • At the same time, gold imports fell to $20 billion from $23.9 billion a year ago.

Impact of moderating CAD on market

  • While rising CAD raises concerns among investors as it hurts the currency and thereby the inflow of funds into the markets, a notable decline in CAD in January has improved market sentiments.
  • Experts believe that CAD is very important for the currency. The value of an economy hinges a lot on the value of its currency and thereby, it also supports the equity markets by keeping the fund flow intact.

Source: IE

 
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