Current Account Deficit Too Wide.

If a country’s current account is in deficit, it would imply that its imports of goods and services are higher than its income from exports and remittances from non-residents .

The current account deficit also implies that the country is pushing for its investments to be higher than that supported by its savings. While India’s savings rate has increased to 33-36 % of GDP from 21-23 % in the early 1990s, investment has also increased commensurately with current account largely remaining deficit.

Since the balance of payments (BoP) crisis in 1991, policymakers, however, have managed to keep the current account deficit within a range of 0.5-2 % of GDP considering the macro stability aspect. Running a small current account deficit for higher investments and GDP growth is the appropriate policy approach for a developing economy. During the initial phase of the take-off , the current account balance for other Asian economies was also in deficit or saw a very small surplus. For instance, China moved into high growth of 9%- plus on a sustained basis for the first time in early 1980s from an average of 6.2% in 1970s. In China, current account balance remained in small deficit or negligible surplus until mid-1990s.

The globalisation of capital markets and the steady rise in capital inflows make it easy to fund the current account deficit through stable non-debt creating inflows. Over the past 10 years, while India’s current account deficit has averaged 0.5% of GDP, net capital inflows have averaged about 3.4% of GDP. The current account plus net FDI has been in a manageable deficit range of 0-1 .5% of GDP over the past 10 years.

Indeed, the total net capital inflows (FDI plus portfolio equity and external debt) have persistently been higher than the current account deficit. The net balance of payments surplus (current account balance plus net capital inflows ) has cumulatively resulted in a rise in forex reserves to over $280 billion as the central bank has intervened to prevent excessive appreciation in the exchange rate.

Policymakers have also ensured that capital inflows are not highly geared towards building external debt. The RBI and ministry of finance’s policies discourage short-term debt inflows. Equity-oriented capital inflows (net FDI plus portfolio equity inflows) have accounted for 55% of total capital inflows over the past 10 years.

Post the 1991 BoP crisis, policymakers in the country have ensured that the current account deficit does not rise above 2% of GDP, a kind of self-imposed prudential limit. However, the dynamics of current account have changed over the past two years. In 2008-09 , for the first time since the 1991 BoP crisis, India’s current account deficit widened to more than 2% of GDP (2.4%). In the first half of 2008-09 , a large spike in crude oil prices in mid-2008 to $145/bbl pushed oil imports up suddenly. Oil balance (imports less exports) deteriorated to -5 .4% of GDP in 2008-09 from -4 .3% of GDP in 2007-08 .

Source : economictimes.indiatimes.com