CAD and its Market Impacts

Context: The RBI Governor said that Current Account Deficit (CAD) is expected to moderate in second half of 2022-23.

What is Current Account Deficit (CAD)?

• Current Account measures the flow of goods, services and investments into and out of the country.
• Current Account Surplus: It indicates that money is flowing into the country, boosting the foreign exchange reserves and the value of rupee against the dollar.
• Current Account Deficit: It is a situation where value of goods and services imported by the country ie country’s imports exceed the value of goods and services exported from the country ie country’s exports.
  • Current Account = Trade Deficit + Net Income + Net Transfers
  • CAD and the fiscal deficit together make up the twin deficits.

Consequences of Current Account Deficit

• Economic growth: In the short-run, a current account deficit is helpful to the debtor nation. Foreigners are willing to pump money into it.
  • That drives economic growth beyond what then country could manage on its own.
• Weakening of demand: In the long run, a current account deficit saps economic vitality.
  • Foreign investors question whether economic growth will provide enough return on their investment.
  • Demand weakens for the country’s assets, including the country’s government bonds.
• Rise in bond yields: As foreign investors withdraw funds, bond yields rise.
  • The national currency loses value relative to other currencies.
  • That lowers the value of the assets in the foreign investors’ strengthening currency.
  • It further depresses investor demand for the country’s assets. This can lead to a tipping point where investors will dump the assets at any price.
• Rise in value of foreign assets: The only saving grace is that the country’s holdings of foreign assets are denominated in foreign currency.
  • As the value of its currency declines, the value of the foreign assets rise.
  • That further reduces the current account deficit.
• Setting in of Inflation: In addition, a lower currency value increases exports as they become more competitively priced.
  • The demand for imports falls once prices rise as inflation sets in.
• Lower Standard of Living: Regardless of whether the current account deficit occurs through disastrous currency crash or a slow, controlled decline, the consequences would be the same.
  • That’s a lower standard of living for the country’s residents.

Trends in CAD

• India’s current account deficit in 2021-22 stood at $38.8 billion. However, Russia’s invasion of Ukraine in late February 2022 led to a massive surge in global commodity prices and pushed the import bill up to record highs.
  • CAD widened to 3.3 per cent of GDP in first half of 2022-23 from 0.2 per cent in the comparable period of 2021-22 on the back of a sharp increase in the merchandise trade deficit.
  • In the July-September quarter of 2022, India’s current account deficit surged to an all-time high of $36.4 billion.
• January trade deficit narrowed to $17.7 billion, led by a sharp fall in imports, while exports fell by a smaller amount.
  • Merchandise exports stood at $32.91 billion in January and imports at $50.66 billion.

Factors Responsible for Moderating CAD

• Drop in Imports: Non-oil imports fell, mainly due to a price impact (softening in coal prices from mid-December) and also likely softening in domestic demand post the festive season (such as lower imports of transport equipment), and seasonal impact of the Chinese New Year holidays.
• FPI outflows have come down to Rs 4,400 crore in February so far.
• Workers’ remittances went up to $30 billion in the April-September 2022 period from $25.48 billion in the same period a year ago.
• Gold imports fell to $20 billion from $23.9 billion a year ago.
• Rise in interest rates in India after the RBI hiked the repo rate by 250 basis points to 6.50%.
• NRI deposits had increased by $3.62 billion to $134.49 billion in the April-November period of 2022.

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