Current Account Deficit

By : Neha Dhyani

Updated : Mar 24, 2022, 9:12

The Current Account Deficit is the difference between money received and sent from a country during the import and export of goods and services. It also considers the net income from domestic production factors overseas.

To better understand CAD, one must first identify what constitutes a nation's current account. The current account records a nation's net transactions with other countries (in terms of goods and services), net profits on overseas investments, and net remittances over time. The account runs into a deficit when money going out exceeds the money coming in.

How is the Current Account Different from Balance of Trade?

Current Account Deficit differs slightly from Balance of Trade (BOT). While BOT only measures the earning gap on export and import of goods and services, CAD also factors net income from your funds employed abroad.

For instance, an Indian receiving rent from his property abroad would be included while calculating CAD but not included while calculating BOT.

Calculate of Current Account Deficit

The nations' current account comprises net profit, dividend, interest, foreign aid, donations, and remittances, among other things. It is calculated as:

Current Account Deficit (Surplus) = Trade Gap + Net Current Transfers +Net Income Abroad

Where, Trade Gap = Exports Imports

Current Account Deficit (Surplus) is calculated as a percentage of the GDP.

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Is Current Account Deficit Inherently Bad?

  • Whether a CAD is bad or not depends upon the factors that give rise to the deficit.
  • If the deficit is due to an excess of imports over exports, it may indicate competitiveness issues.
  • However, some countries use external debt to finance lucrative investments. CAD may not be disadvantageous in such cases, provided the return on investment is higher than the interest on the debt.
  • But again, a deficit can also reflect low savings rather than high investment. It can be due to a reckless fiscal policy and excessive consumption.
  • So without knowing the underlying factors behind a deficit, one cannot decide if it's detrimental to the economy.
  • Developed countries like the US often run Current Account Deficits while emerging economies mostly run surpluses.

How to Deal with Current Account Deficit?

  • The Current Account Deficit is caused by several factors like exchange rate, inflation, rise in consumer spending, current interest rate, etc.
  • Imports of gold and crude oil are the two major causes of high CAD in India.
  • CAD can be curbed by increasing exports, reducing imports, and hedging currency, among other measures.
  • Bringing out policies to promote ease of business and improve domestic companies' competitiveness can help reduce CAD.
  • Similarly, the Reserve Bank and the Government could also consider reviewing the debt investment limit for Foreign Portfolio Investments (FPIs).

Current Account Deficit in India FY 2022

  • As per the RBI press release dated 31st Dec 2021, India's current account recorded a US $ 9.6 billion (1.3 % of GDP) deficit in the second quarter (July to September) for FY 2021-2022.
  • The deficit contrasts with the surplus of US $ 6.6 billion (0.9% of the GDP) in the first quarter (April to June) of FY 2021-2022. The account was also in surplus to the tune of $ 15.3 billion the same quarter last year.
  • RBI points out that the deficit was mainly due to -the "widening of trade deficit to $44.4 billion from $30.7 billion in the preceding quarter and an increase in net outgo of investment income".
  • Experts predict the CAD for the year to rise to $40 to 45 billion, around 1.4% of GDP.

A large Current Account Deficit [CAD] may spell trouble for India on the inflation front. However, RBI and the government can control this by adjusting their policy response to growth.

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FAQs on Current Account Deficit

Q.1. What is the Current Account Deficit?

The Current Account Deficit (CAD) is the shortfall in money coming in from export compared to the money flowing out on imports.

Q.2. How is the Current Account Deficit calculated?

Current Account Deficit (Surplus) = Trade Gap + Net Current Transfers +Net Income Abroad.

Q.3. How is the Current Account Deficit different from the Balance of Trade?

BOT only measures the earning gap on export and import of goods and services while CAD also factors payments from domestic capital employed abroad.

Q.4. What is India's Current Account Deficit for the 2nd quarter of FY 2022?

India's Current Account Deficit was US $ 9.6 billion (1.3 % of GDP) in the second quarter of FY 2022.