According to the RBI’s quarterly figures, the current account deficit (CAD) increased from 2.2% of GDP in the first quarter of 2022–23 to 4.4% in the second.
The extraordinary surplus, in comparison, for 2020–21 was 0.9% of GDP. The worsening of the merchandise trade imbalance may cause a decline in the CAD during the third quarter of the current fiscal year.
In the third quarter of 2022-2023, the global trade deficit decreased from $49.1 billion in the second quarter to $37.73 billion. According to the most recent data, the trade imbalance dramatically decreased in January, falling to $1.27 billion, as a result of a significant increase in net services exports.
Is there a concern with the current account deficit?
There are both positive and negative elements in Indian CADs.
A planned deficit is a natural result of increasing investment, portfolio decisions, and national demography.
Yet, if they are supported by fragile finances and indicate broader issues like low export competitiveness, high and prolonged CADs might not be favoured.
According to economists, external shocks have a significant impact because the country’s CAD often increases when output declines rather than when demand increases.
For instance, if oil were used as a production input, the price of oil would rise, increasing production costs and impeding economic growth. CADs increase in line with slowing growth due to the inelastic demand for oil imports in the current environment and its significant share of all of India’s imports.
To reduce the CAD, stable capital flows are preferred:
India is subject to the financing-related risks as a result of sizable and continuous CADs.
CADs are preferable because they are less susceptible to capital flight, so long as they can be financed by reliable capital inflows, such as FDI inflows.
But, if deficits are supported by irregular capital movements, such as portfolio flows, there may be reason for concern. During a worldwide financial crisis, portfolio adjustments are unpredictable and more likely to go the other way.
Finance structure is very important. Even though FDI inflows were sufficient to cover the deficit in 2021–2022, they have proven insufficient for the present fiscal year.
Only about 18% of CADs were funded by portfolio and FDI inflows in the second quarter of 2022-23.
There is a financial problem as a result. Stable capital flows are preferred because they enable debtor nations like India to use and allocate funds to industries with the potential to boost long-term productivity and economic growth.
The usage of services and remittance are required to balance the CAD:
Rising merchandise trade imbalances have been lowered by remittances and service exports.
In 2021–2022, India’s service exports increased by 23.5%. Service exports increased by 32.7% in the first half of 2022-2023 compared to the same period in the previous year.
Also, between April and September 2022, remittances increased by 25% and reached $48 billion. Remittances have shown exceptional stability compared to capital flows, which are pro-cyclical and react negatively to the Fed’s contractionary monetary policies.
Policymakers ought to take the medium-term economic outlook into account:
Policymakers need to stop the damaging effects of the global trade slowdown on product exports in the medium run.
If the US Fed increases rates further, there could be a capital flight, which would put extra pressure on the exchange rate market.
This could be difficult given the current status of the economy because an unstable import basket and a weak currency will result in imported inflation.
So, in order to increase exports, the government must simultaneously negotiate free trade agreements and concentrate policy initiatives on structural improvements to increase trade competitiveness.
High fiscal and CAD deficits are the two deficit issues that India is now dealing with.
Aggressive fiscal consolidation might not be the best course of action in light of growing concerns about a global recession. Yet, a comfortable external environment can be maintained by offering consistent finance and employing currency rates as a shock absorber to navigate the challenging global economic climate.