India’s current account deficit (CAD) recently hit a four-quarter high at 2.4% of gross domestic product (GDP) in the April-June period from 1.9% in the January-March quarter of 2017-18. The current account is a critical indicator of an economy’s strength or weakness, as it measures the flow of goods, services, and investments into and out of the country. For India, the current account largely consists of its trade balance with the rest of the world and private transfer receipts, primarily representing remittances. A surplus would denote that India is a net lender to the rest of the world, while a deficit suggests it’s a net borrower.
Reasons behind CAD Increase
High crude oil prices above the $75-a-barrel benchmark, spurred by tensions in the Gulf region, U.S. sanctions on Iran, and instability in Venezuela, a significant oil-exporting nation, is one of the reasons why the CAD is rising. Given that India is a net importer of fuel, these soaring prices have invariably led to an increase in the country’s trade deficit. Additionally, a depreciating rupee has made imports more expensive.
The escalating trade war between China and the U.S. could potentially hamper export growth. Moreover, an increase in demand for investment leads to more imports, further straining the trade balance.
Concerns Associated with CAD Financing
CAD is financed through a concoction of foreign direct investment (FDI), portfolio flows, and foreign reserve management. However, given the rising global volatility, financing CAD has become a cause for concern. While FDI flows have seen an uptick in recent years, a robust dollar and stringent global financial conditions have piled on additional pressure on portfolio investments.
The International Monetary Fund (IMF), assessing India’s historical cash flows and capital inflow curbs, has predicted that global markets might be unable to finance a CAD above 3% of GDP. This higher CAD could apply further pressure on the rupee and potentially elevate the cost of overseas borrowing.
Potential Impact of Depleting Forex Reserves
Depleting foreign exchange (forex) reserves could exacerbate the CAD situation. Forex reserves offer a cushion of liquidity that can be utilized in times of economic stress. However, continuously dipping forex reserves could suggest that this buffer is being used, which may lead to reliance on more volatile types of financing. The subsequent strain on India’s external sector stability can eventually result in a higher CAD.
To sum up, the issue of the expanding CAD in India is complex and multi-faceted. It encompasses diverse elements such as escalating global oil prices, the ongoing China-U.S. trade war, complex investment dynamics, and depleting forex reserves. How these factors play out in the future and the policies India adopts to address them will shape the trajectory of its current account deficit.