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Why is Current Account Deficit so bad this time?
India’s current account deficit (CAD) touched a record high of $ 32.6bn or 6.7% of gross domestic product for the quarter to December 2012. This deficit occurred because more money was paid out of India than brought into the country.If a country primarily imports more than it exports, it runs a current account deficit.
The Reserve Bank of India governor, D Subbarao said last month that the sustainable CAD for India is 2.5% of GDP. Finance minister, P Chidambaram has said that such a high current deficit was ‘worrying’.
This has raised concerns over the impact on the economy.
Here are pointers that could explain the situation:
Quality of India’s imports is worrying: An economy that is growing at a faster clip than other nations has high imports and usually runs a current account deficit. The RBI governor, D Subbarao has expressed concern about the quality of imports. He argued in a speech last month that if a country imports more capital goods, it means there is an increase in the economic activity. Companies import capital goods equipment only when they expand capacities. However, India’s imports primarily include oil and gold. These two commodities do not help any manufacturing and export growth. India’s oil imports rose despite an overall economic slowdown. India also continued to import gold as demand stayed high. This was despite the additional duties imposed on import of gold.
No signs of exports growth: India’s overall trade deficit stood at $ 59.6bn during the quarter to December 2012. This is the excess value of imports over exports. India’s exports fell marginally due to an overall slowdown in demand for goods and services overseas. With overall slowdown in the global economy, there are few signs of a sharp surge in exports
Impact on the Rupee: A high current account deficit puts pressure on the value of the rupee. However, the Indian rupee has not witnessed a sharp fall so far. This is due to strong flows from foreign institutional investors into equity markets as well as foreign direct investment by companies. This largely finances the current account deficit. The RBI also ensures that the rupee does not fall sharply, as this could increase the inflation in the economy. It conducts periodic ‘intervention’ in the foreign exchange markets by selling foreign currency and buying the rupee.
What is government doing? Finance minister, P Chidambaram was in Tokyo this week. He said that the Indian economy could easily absorb close to $ 50bn in foreign direct investment and more in foreign institutional investment. He was in Japan to woo foreign institutional investors to India. Ahead of the presentation of the budget in February 2013, he went to Hong Kong and London. The RBI governor, Subbarao has cautioned against depending too much on volatile foreign flows. He said in his speech in March 2013 that the country was exposed to the risk of a sudden stop and exit of capital flows. “Should the risk of capital exit materialize, the exchange rate will become volatile causing knock-on macroeconomic disruptions,” he cautioned.
India’s total external debt stood at $ 376bn as December 2012, according to RBI data. A high growth economy usually witnesses a rise in borrowing. However, the worrying factor is the quality of the borrowing. The short-term debt, the borrowing with a term of less than one year, rose to $ 92bn or 5% of GDP. This means the country could potentially see an outflow of money in less than a year and could put a downward pressure on the Indian rupee. A sharp fall in the Indian rupee could add to high inflation.