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Explained: What is the Current Account Deficit, which widened in Q3 of the last FY?

The widening of CAD in Q3 of 2021-22 was mainly on account of higher trade deficit, according to the Reserve Bank of India.

India's Current Account Deficit increased to $23 billion (2.7% of GDP) in Q3 of 2021-22.

India’s Current Account Deficit (CAD) increased to $23 billion (2.7 per cent of GDP) in the third quarter (Q3) of 2021-22 from $9.9 billion (1.3 per cent of GDP) in Q2 of 2021-22 and $2.2 billion (0.3 per cent of GDP) in Q3 of 2020-21.

The widening of CAD in Q3 of 2021-22 was mainly on account of higher trade deficit, according to the Reserve Bank of India. Net services receipts increased, both sequentially and on a year-on-year (y-o-y) basis, on the back of robust performance of net exports of computer and business services, the RBI said.

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What is the CAD?

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Exchange rate of rupee

Every day, Indians and Indian entities — such as firms and governments — import foreign goods and services, export domestic goods and services, receive investments from abroad, and make investments in other countries.

Each of these transactions involves either a demand for foreign currency — for example, you need dollars to import something from the US or to invest in one of the US stock exchanges — or a demand for Indian currency (by the same logic).

The interplay of these transactions decides the exchange rate of the rupee vis-a-vis the foreign currency (say the dollar).

Recording of transactions

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That notebook, or slate or ledger, is called the Balance of Payment, or BoP. The BoP has two parts.

One is the capital account. This includes all types of trading in capital. In other words, all investments inside and outside the country are recorded here — for example, if an Indian firm invests money in the US to build a new company there, or if an Indian buys stocks on an American exchange.

The second part of the BoP is called the Current Account. Here, all the trade in goods and services is noted down — for example, if an Indian imports an American gadget or software made by an American company or if an American entity imports Indian steel or engages an Indian IT company to create a software.

The Current Account, then, has two specific sub-parts:

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1) Import and Export of goods — this is the “trade account”.

2) Import and export of services — this is called the “invisibles account”.

Current Account Deficit

It is possible that a country — say India — imports more goods (everything from cars to phones to machinery to food grains etc.) than it exports. In such a case, it would have a “deficit” on its trade account. In other words, more money is going out of the country than coming in via the trade of physical goods.

However, India could be enjoying a surplus on the invisibles account. This may happen because its software industry is very capable, efficient and competitive, and exports lots of software solutions — or because Indians working in the US send lots of money back home to their families.

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The net effect of this surplus (or deficit) on the invisibles account and the deficit (or surplus) on the trade account is called the current account balance.

If, as is more often the case with India, there is a huge trade deficit and a smaller surplus on the invisibles, then what we have is an overall deficit on the current account — or Current Account Deficit.

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In essence, having a CAD or a deficit on the current account implies that, in monetary terms, India imports more goods and services than it exports. This, in turn, implies that the demand for the foreign currency (say the US dollar) is more than the demand for the Indian rupee.

That, in turn, implies that the rupee will depreciate. Whether or not it eventually does depreciate, however, depends on what is happening to the Capital Account of the BoP.

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First published on: 01-04-2022 at 06:42:00 pm
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