Current Account Deficit: A frightening reality for India

A persisting global economic crisis has India caught up in a cobweb of dormant growth, surging inflation and the ballooning fiscal deficit has one more predicament knocking on its door namely the Current Account Deficit (CAD).

Where USA is searching for measures to counter the fiscal great wall and China for the first time in a decade is apprehensive about its growth stalling, other countries are worried over decline in the global consumption and India is faced with this predicament.

What is a Current Account Deficit?

A current account of any country is the difference of its overall export of goods, services and imports exclusive of financial assets and liabilities. A superfluous current account increases country’s net foreign assets, giving positive signs about its foreign trade and any cutbacks turn it into a debtor.

India recorded a CAD of $16.40 billion in the second quarter of 2012 and CAD as a fraction of national gross domestic product (GDP) was slightly up at 3.9% for first quarter (Q1) for FY13 from 3.8% for Q1 of 2011-12 as per the Reserve Bank of India (RBI) data.

The numbers are way below the 4.2% of GDP that was registered in first half of 2011-2012. RBI holds a sustainable current account to GDP ratio a t 2.5 %. During the 1991 balance of payment crisis that India faced the CAD was 3 percent.

With the global slowdown including the lingering European crisis impacting exports, India is registering its worst ever Current Account Deficit in history and increasing demand for oil and gold only compound the problem.

Not being a manufacturing hub like China, India cannot match the dragon nation in terms of an export driven economy but software exports have come to occupy a big chunk is Indian GDP.

A trade deficit with 48 countries over the last three years, with the trend continuing unabated is another factor for increasing CAD.

With a trade deficit ($40 billion) against China for 2011-12, it is a very frightening scenario for India.

Major factors contributing towards rising CAD

Gold – For India, Gold is the biggest contributor towards increasing Current Account Deficit. Import of the yellow metal alone contributes approximately 90% towards it as historically India remains the largest consumer of gold in the whole world.

In the second quarter of 2012 alone 223 tonnes of gold was bought and the current price of 10 grams of gold is hovering around Rs 31,000. In just over a year, it has sharply risen from about Rs 19,000.

Government data shows that the country spent $60 billion on bullion imports in 2011-2012 where 969 tons of gold was bought while India’s gold reserves stand at $26.24 billion and forex reserves as on September 2012 were at $293 billion.

 Projections have been made that the country could end up importing 1000 tons of gold in the current year. The prevailing high price of gold though has slowed down demand but not enough to arrest the deficit.

Oil – An oil deficit nation, India imports as much as 80% of its crude oil requirements and the bill jumped up from $100 billion in 2012-11 to $ 140 billion in 2011-12.

The sharp spike in oil prices from $ 27 to over $ 100 per barrel compounded with the substantial depreciation of the rupee against the dollar has only added to the nations woes in containing CAD.

Countering Current Account deficit problem

A weakening rupee has only made more and more investors turn buying gold as a hedge against the prevailing uncertain economic scenario.

Measures like doubling import duty on gold from 2 to 4 percent, RBI banning bank lending for buying gold are not enough. Lack of better investment options is driving the gold prices higher and higher and only a better investment option such as gold ETF’s, gold linked accounts, gold deposits and better pension schemes could reduce the demand for physical gold.

Increasing domestic production by auctioning blocks like those done for oil and gas sector would deploy private capital to raise output and reduce the dependence on imports.

Reducing subsidy on the oil bill by aligning petrol, diesel and gas prices to that of global market prices, would not only help in judicious use of the non renewable energy resource but also curb the current deficit account that the country faces on account of it.

To arrest declining exports, schemes like the modified Special Incentive Package Scheme (SIPS) and extension of 2% subsidy are expected to bring some changes in the nations export figures.

Other measures the government could employ is increasing tariffs on imports and devaluing the rupee more to make Indian exports competitive in the global market.

The balance of payment crisis India faced in 1991 is a stiff reminder of what a persisting current deficit could do to the nation’s economy.

Tough measures, like then, would have to be adopted now even to pull the country back on the path of growth and economic strength. The recent half-hearted reform measures taken have shown that course correction is possible but much more needs to be done if CAD is to be reigned in.

A mechanical engineering graduate with a post graduation in marketing and sales, Ashish has combined professional experience of more than 4 years. Ashish is a great fan of Martin Scorsese. He loves to write poetry in his spare time. He lives in Shimla.

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