n economics, a country may face a current account deficit (CAD) when the value of imports of foreign goods, services, as well as international transfers of capital, exceeds the value of exports.
So, does the current account deficit mean it’s bad for the economy? Let’s look at its prospects and downside effects.
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What is a Current Account Deficit?
A current account deficit (CAD) occurs when the country’s expenditure is more than its income. Similar to a current account opened by a business to keep track of the inflow and outflow of money, in terms of the nation’s economy, it monitors the transaction of funds made from import and export of goods and services to and from India and foreign nations, and is measured in the U.S. dollar.
Thus a current account deficit may occur when the country’s expenditure in imports is more than its income from exports of goods and services. However, the current account may be “surplus” when it generates more funds from exports than it spends on importing goods and services.
CAD records every transaction including foreign investment on an Indian company, or transfer of money made by an individual back home in India over a period, though these transactions make up only a small percentage as compared to import and export of goods and services.
CAD is an important tool to measure the health of a country’s economy. In India, the Reserve Bank of India (RBI) releases the CAD data every financial quarter, which is measured in the U.S. dollar and as a percentage of a gross domestic product (GDP).
Understanding a Current Account Deficit
Let’s understand the components of a current account, and see how a deficit may occur.
Exports and imports of goods and services: In a foreign trade, exports and imports refer to selling and buying of goods and services to and from India and other nations. Trade in merchandise goods and services adds up as the major contributor to the nation’s economic growth vis-a-vis flow of money. A trade deficit is the largest contributor to the current account deficit.
According to the government data, the value of India’s overall exports in Mar. 2023 is estimated to have touched USD 66.14 billion, while imports stood at USD 72.18 billion during the same period. This means that India’s expenditure on imports was more than its income earned from export of goods and services during the period.
Flow of income: A current account also measures the country’s flow of income, which includes profit, interest and dividends. It includes transactions made by individuals, companies, and government bodies with entities outside the country. A deficit in a current account may occur if the country is sending more money abroad than it is receiving.
Current transfers: This includes transfer of money sent and received by entities mainly in the form of remittances.
How to Calculate the Value of a Current Account?
A country’s current account deficit is measured in the U.S. dollar, and as a percentage of GDP. It calculates the value of import and export of goods and services, which takes into account the sum of trade balance, as well as net income, and private current transfer made during a financial quarter, or a financial year.
The following formula is used to calculate the country’s current account deficit.
Trade gap = Exports – Imports.
Current Account = Trade gap + Net current transfers + Net income abroad.
Latest Current Account Deficit News in India (Updated April 25, 2023)
April 25, 2023: India current account deficit declines 2.2% of GDP
India’s current account deficit (CAD) declined 2.2% of gross domestic product (GDP) to USD 18.2 billion in the third quarter of the financial year 2022-2023, according to the data released by the Reserve Bank of India (RBI). The country’s CAD was 3.7% (USD 30.9 billion) of the GDP in the previous quarter.
RBI states that the Q3 decline in CAD is mainly due to a reduction in the trade deficit of goods to USD 72.7 billion from USD 78.3 billion in the second quarter. Exports in the services sector witnessed 24.5% growth, while net foreign direct investment declined to USD 2.1 billion. Meanwhile, private sector transfer receipts, which are remittances made by Indian citizens working overseas, stood at USD 30.8 billion.
A country’s current account deficit is measured as a percentage of GDP. The central bank projects real GDP growth for 2023-24 at 6.4% with Q1 at 7.8%, Q2 at 6.2%, Q3 at 6.0%, and Q4 at 5.8%.
How would a Large CAD Affect the Economy?
A current account deficit occurs when the expenditure on imported goods and services exceeds the value of exports. Let’s look at some of the adverse effects of a large current account deficit to the economy.
- Foremost, a large current account deficit for a continued period of time can lead to depreciation of rupee, and the demand for foreign currency (especially dollars) will see a rise.
- Concomitantly, the depreciation of rupee, as a result of continued deficit in the country’s current account, will see prices of imported goods becoming costlier, and in turn pushes the country towards inflation.
- Investors will start becoming wary to invest in India, whereas existing investors will have a greater claim on domestic assets.
While a current account deficit may sound like a bad thing that can happen to the nation’s economy, this is not necessarily the case. Economists suggest that whether a current account deficit is good or bad for a nation depends on identifying the factors giving rise to it, and effectively assessing.
How can India Moderate Current Account Deficit?
Here is a list of factors that can moderate India’s current account deficit, as follows:
- Reduce the price of commodities.
- Appreciation of rupee.
- Lessen debt taken from developed nations.
- Reduce foreign ownership of assets.
- Improve the quality of imported goods.
- Reduce non-essential imports of gold, mobiles, and electronics.
- Increase value of exports.
- Government policies to boost exports of goods and services to foreign nations.
Frequently Asked Questions (FAQs)
Why does CAD matter?
For any nation, the current account deficit matters as it measures the current economic situation of a country, especially its performance related to trade and investment.
Difference between current account deficit and trade deficit?
Current account deficit occurs when a nation sends more money abroad than it receives. A trade deficit is the largest component of a current account deficit, which occurs when a country imports more than it exports in a given period of time.
What is a trade deficit and how does it affect the economy?
A trade deficit occurs when a country imports more than it exports in a given period of time. Trade deficit is the largest contributor of a current account deficit, and puts a significant impact on the country’s economy as mentioned above.
