A current account deficit occurs when a country’s total payments to the rest of the world exceed its total receipts from the rest of the world on the current account.
- It is an important component of the Balance of Payments (BoP)
Current Account Balance=Trade Balance+Net Services+Net Primary Income+Net Transfers
- Trade Balance: Exports and imports of merchandise.
- Net Services: Software services, tourism, shipping, banking, insurance, etc.
- Net Primary Income: Interest, dividends and profits received from or paid to foreign countries.
- Net Transfers: Remittances, gifts and foreign aid.
Causes of CAD
- Domestic Causes
- Rapid economic growth increases imports of capital goods, energy and raw materials.
- Low export competitiveness.
- High dependence on imported crude oil and gold.
- Weak manufacturing and limited value addition.
- Appreciation of the domestic currency can make exports relatively expensive.
- Excessive domestic demand and consumption.
- External Causes
- Rise in global crude-oil prices.
- Global slowdown reducing demand for exports.
- Supply-chain disruptions.
- Depreciation of the domestic currency increasing the import bill.
- Higher interest and dividend payments to foreign investors.
Effects of a High CAD
- Pressure on the Currency: Demand for foreign currency rises, causing depreciation of the rupee.
- Imported Inflation: Imported fuel, fertilisers and raw materials become costlier.
- External Vulnerability: The country becomes dependent on foreign capital to finance the deficit.
- Higher External Debt: Borrowing may increase if stable capital inflows are insufficient.
- Reduced Investor Confidence: A persistent and large CAD may make investors concerned about external stability.
- Pressure on Foreign-Exchange Reserves: The central bank may need to use reserves to manage excessive currency volatility.
Source: The Hindu