India’s trade deficit has been experiencing a steady increase since July 2021, according to a recent report by British brokerage Barclays. The expanding Current Account Deficit (CAD) is primarily caused by the massive surge in commodity prices spearheaded by crude oil. The report anticipates that by March 2022, CAD will hit $45 billion or 1.4% of GDP, which could potentially impede the delicate economic revival process.
Understanding Current Account Deficit
A current account deficit arises when a nation’s overall expenditure on imported goods and services outstrips the total value of its exported goods and services. The difference between the value of exports and imports is known as the trade balance, which forms part of the ‘Current Account Balance’.
The Driving Forces behind India’s Current Account Deficit
Two crucial factors affecting India’s current account deficit are high oil and gold imports.
Firstly, approximately 85% of India’s oil demand is met through imports. Therefore, it’s predicted that a $10 per barrel hike in worldwide crude oil prices would push the trade deficit up by $12 billion or 35 bps (basis points) of the GDP.
Secondly, an increase in gold imports, fuelled by recovering domestic demand and the ongoing festive season, has also contributed to the decline in foreign exchange. The World Gold Council foresees the demand for gold outdoing the 2020 levels, given the escalating wealth impacts and rising incomes.
However, the report also highlights that the monthly services surplus improved from an average of $6.6 billion in 2019 to $7 billion in 2020, and further to $8 billion in the first nine months of 2021.
Overall Impact and Balance of Payments Definition
Despite the growing deficit, the report doesn’t predict any major threats to macro stability or balance of payments. Nevertheless, this trend might persist due to the combination of surging commodity prices and demand recovery.
In terms of economics, a country’s Balance of Payments (BoP) is a comprehensive record of all its economic transactions with the rest of the world over a certain period, usually a year. BoP calculations offer insights into a country’s financial and economic status, helping governments devise fiscal and trade policies. They also aid in understanding a nation’s economic relationships with other countries.
Components of Balance of Payments
The preparation of BoP accounts involves categorizing a nation’s economic transactions with the rest of the world under three headings: the Current account, Capital account, and Errors and Omissions. It also includes changes in Foreign Exchange Reserves.
The Current Account represents the trade balance by showing the import and export of visibles (also known as goods or merchandise), and invisibles (services, transfers, and income).
The Capital Account gives a summary of a country’s capital expenditure and income, reflecting the net flow of private and public investments into the economy.
Errors and Omissions reveal any discrepancies in the BoP, reflecting a nation’s inability to accurately record all international transactions.
Finally, the changes in Foreign Exchange Reserves showcase shifts in the foreign currency assets held by the Reserve Bank of India (RBI) and in Special Drawing Rights (SDR) balances.
To conclude, a BoP can either be in surplus or deficit. A deficit can be addressed by drawing money from the Foreign Exchange (Forex) Account, but if reserves in the forex account are inadequate, it could lead to a BoP crisis.