India has faced massive Current Account Deficits
(CAD) for most of the period of planning. The
problem has reached alarming proportions, during
the recent years because of a number of factors
operating on the domestic and international fronts.
What is Current Account Balance?
Broadly speaking, Current Account Balance is the
difference between a country’s total exports and
imports. It includes, apart from the balance of trade
merchandise exports and imports), balance of services
and balance of unilateral transfers. Balance of services
records the difference between the monetary value of
all the services exported/rendered and imported/
availed by a country in a year. These services could
relate to transportation, banking, finance, insurance,
tourism etc. Balance of unrequited transfers includes
balance on account of gifts, donations, grants and
remittances. All these balances, i.e., balance of trade,
balance of services and balance of unrequited transfers
constitute balance of current account. It could be
positive, negative or zero depending upon the values
of these balances. It is worth noting that balance of
payments on current account covers all receipts on
account of earnings (as opposed to borrowings) and
all the payments arising out of spending (as opposed
to lending).
What is the position of India’s Current Account
Balance?
At present, India’s has a negative Current Account
Balance, i.e. receipts on account of export of goods
and services and unilateral receipts (donations, grants
transfers etc.) are less than payments on account of
imports of goods and services and unilateral
payments. In other words we can say that there is
Current Account Deficit (CAD) in India’s Balance of
Payments (BOP) Accounts.
Is this a new development or has India always faced
CAD?
Over the period of planning, India’s balance of current
account has generally remained unfavorable. This is
because after Independence, it had to initially import
heavy machines, technology and capital equipments
etc. to carry out the programme of industrialization.
As pace of development picked up, it had to have
maintenance imports. Moreover, since it had mostly
primary goods like tea, coffee, jute etc. to offer as
exports, it generally had unfavourable balance on
current account.
There were short spurt of times when India
experienced a surplus in the balance of current
account. For example, during Fifth Plan, India had a
small surplus in the balance of current account. This
relatively comfortable position was mainly due to (i)
rapid increase in private remittances from oil
exporting countries. A large number of Indian workers
had migrated and worked there. They kept sending
their net earnings to their families in India. (ii) Strong
growth of exports (iii) increased domestic production
and low imports of oil. From 1979-80 onwards, India
started experiencing adverse balance of payments
situation. This happened because continuous increase
in oil prices led to huge trade deficits. However, since
earnings from invisibles were substantial, the current
account had positive balance.
The Sixth Plan was characterized by difficult balance
of payments situation. This happened because
earnings from invisibles started flattening out.During
the Sixth Plan, the current account deficit was 1.4
per cent of GDP which increased to 2.4 per cent in
the Seventh Plan. The large and sustained current
account deficit in the BOP had to be financed by
substantial inflow of capital in the form of loans from
various sources, commercial borrowings and inflow
of funds from NRIs. In early 1990-91, the already poor
BOP position worsened because of Gulf War and
further deterioration in invisible remittances. An
immediate response to the BOP crisis was introduction
of a new system of exchange rate management,
liberalization of import licensing and tariff reductions.
This has had a significant positive impact on the
country’s balance on current account.
There has been a significant improvement in of India’s
balance of payments positions since the initiation of
economic reforms in 1991. Comparing the pre-crisis
with the post crisis data we find that exports grew at
an annual average of 7.6 percent during 1980-1992
and at an annual average of 10 per cent during 1992-
2001. Similarly, imports grew at 13.7 percent per
annum during 1992-2001 compared with just 8.5 per
cent growth rate during 1980-92. Moreover, the CAD,
as percentage of GDP declined from 1.9 per cent during
May 2013 I The Chartered Accountant Student 19
ECONOMY
pre-crisis period (1980-92) to around 1 per cent during
post-crisis period (1992-2001) and during 2001-04 we
even had surplus in the current account. This
improvement in current account balance was made
possible largely because of the dynamism in export
performance, especially software services, sustained
buoyancy in invisible receipts particularly private
transfers comprising remittances and subdued nonoil
import demand. Since 2003-04 trade deficit has
widened because of higher outgo on import of
petroleum, oil and lubricants.
What is the present position of CAD?
India at present is facing a large and an increasing
CAD. The CAD at present (2012-13) at 5% of Gross
Domestic Product (GDP) is higher than it was in 1991
(3% of GDP). It touched an all time high level of $33bn
in the quarter ending December 2012, reaching a
historical record level of 6.7% of GDP. It is needless
to say that the soaring deficit is “worrying”.
What are the causes of the present high level of CAD?
The global financial crisis, which set in 2008-09, has
affected India’s external sector. India’s current account
deficit has increased due to weak exports and
increased imports.
The growth rate of exports has fallen from 37% in
2010-11 to 23.7% in 2011-12.There has been a
significant decline in the rate of growth of exports of
engineering goods, textiles, petroleum products, gems
and jewellery, chemicals and iron ore. Growth in
invisible receipts also decelerated mainly because of
lower growth in exports of services, private transfers
and decline in investment income.
The growth rate of imports has risen from 27% in
2010-11 to 31% in 2011-12. The increase in imports
is largely on account of heavy gold and crude oil
imports. The rise in gold imports is due to many
factors. India is one of the largest consumers of gold
in the world and it accounts for one third of total world
gold consumption. Since domestic production of gold
satisfies just 0.3% of domestic gold demand, the rest
has to be met from imports. The worsening global
situation has also led to a rise in purchase of gold as a
safety metal and as an investment option. This has
led to further rise in its price. Gold imports account
for nearly 10% of India’s total imports. Substantial
increase in international gold price has contributed
to sharp rise in the value of gold imported by India in
recent years. Petroleum, Oil and Lubricants (POL)
imports account for more than 30% of India’s import
bill. Due to sharp increase in POL prices also, India’s
import bill registered a high growth.
What are the consequences of consistent high level
of CAD?
• India is a $1.8 trillion economy. Imports account
for about 25% of its GDP. Inability to pay for
imports can affect the credibility of the economy,
as a very high level of CAD increases the risk of
non-payment.
• Consistently high level of CAD means that India
will have to arrange for foreign currencies to settle
its import liabilities. This can affect the foreign
exchange rate of the country. This, in turn, will
put pressure on the rupee and weaken its value.
• India will have to arrange for loans and invite
foreign investments in order to cover the
widening current account gap.
• It may need to draw down its foreign exchange
reserves.
What steps should be taken by India to reduce the
deficit?
In order to reduce the yawning CAD, following
measures may be taken:
• Improve exports: Exports have slowed down due
to supply constraints and subdued exports
demand. While not much can be done for
improving demand for exports (which depends
upon the financial conditions of the importing
countries), at least steps should be taken to
remove supply constraints and export-related
regulatory bottlenecks.
• Curb unnecessary imports: There is also a case for
curbing non-productive imports. The Government
has already taken steps in this direction. For
instance, in a bid to curb gold imports, the import
duty on gold has been raised from 4% to 6%.
• Increase awareness: Public needs to be made
aware that buying gold bonds is better than
hoarding gold ornaments.
• Improve oil production: India needs to improve
domestic energy production by enhancing R&D,
exploring new oil fields and using renewable
energy sources like wind.
The ultimate solution lies in improving the
performance of the economy. We need to remove the
structural and infrastructural constraints. Once the
industrial production improves, exports will increase
and the economy will come back on the high growth
trajectory. There is also a need to check inflation as it
is due to high inflationary trends in the economy that
gold has become a favorite saving option pushing up
its import considerably.
BY:- Prem J Bhutani
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