A current account deficit occurs when a country’s total value of goods and services it imports exceeds the total value of goods and services it exports. This balance is an integral part of the ‘Current Account Balance’. A country’s balance of payments (BoP) encapsulates all economic transactions between the country and the rest of the world during a specific period, usually a year. The forex reserve, on the other hand, cushions the economy against funding risks. This reserve currently stands at USD 681 billion.
The widening Gap: Current Account Deficit projected for FY23
Morgan Stanley, an American financial services company, has recently predicted that the Current Account Deficit will widen to a 10-year high of 3% of GDP in FY23. Ongoing geopolitical tensions and a sustained surge in oil prices likely to exacerbate this deficit through a higher oil import bill.
Balance of Payments Deficit
The Balance of Payments (BoP) is estimated to be in deficit of approximately 0.5-1% of GDP (Gross Domestic Product). This is due to the capital flows that are anticipated to be lower than the current account deficit.
Policy Normalization and its Impact
Morgan Stanley expects the policy normalization process to begin with a reverse repo rate hike in April 2022. Should the RBI delay this process, disruptive policy rate hikes’ potential risk increases. There is limited room for fiscal policy stimulation to support growth due to high deficit and debt levels.
Measures to mitigate Current Account Deficit
Possible government actions include devaluing the domestic currency, reducing export subsidy, and fostering policies that attract more Foreign Direct Investments (FDIs) and funding from Foreign Institutional Investors (FIIs). These strategies can help reduce the current account deficit.
Understanding Balance of Payments
The BoP of a country presents a comprehensive statement of all economic transactions of the country with the rest of the world over a specific period, typically a year. It reveals the economic and financial status of a country, informs fiscal and trade policies, and provides information for analyzing the nation’s economic dealings with other countries. The BoP comprises the Current account, Capital account, and Errors and Omissions, indicating changes in Foreign Exchange Reserves.
Components of BoP
The Current Account includes export and import of goods and non-merchandise like services, transfers, and income. The Capital Account shows a country’s capital expenditure and income, summarizing the net flow of both private and public investment into an economy. The External Commercial Borrowing (ECB), Foreign Direct Investment, and Foreign Portfolio Investment form part of the Capital Account. Errors and Omissions reflect inaccuracies in recording international transactions. Changes in Forex Reserves are indicated by movements in the reserves held by the Reserve Bank of India (RBI) and Special Drawing Rights (SDR) balances.
Dealing with BoP Deficit
A deficit in BoP could be covered by drawing money from the Forex Account. However, if the reserves in the forex account fall short, it results in a BoP crisis. In conclusion, understanding and managing the Current Account Deficit, Balance of Payments, and Forex Reserves are crucial for a nation’s economic stability and growth.
