Current account deficit moderates to 0.2% of GDP in March quarter: What is CAD and why has it shrunk?

First, what is Current Account Deficit or CAD?

The current account deficit or CAD is a key indicator of a country’s external sector. When the value of the goods and services that a country imports exceeds the value of the products it exports, it is known as the current account deficit. Together with the fiscal deficit, which is the amount of money that the government has to borrow in any year to fill the gap between its expenditures and revenues, the two make up the ‘twin deficits’ that are considered the enemies of the stock market and investors.

If the current account – the country’s trade and transactions with other countries – shows a surplus, that indicates money is flowing into the country, boosting the foreign exchange reserves and the value of the rupee against the dollar. These are factors that will have ramifications on the economy and the stock markets, as well as on returns on investments by people.

How much did CAD shrink in Q4 of FY2022?

CAD narrowed to $1.3 billion, or 0.2 per cent, of the GDP in the January-March quarter of FY2023 – from $16.8 billion or 2 per cent of GDP in the preceding quarter. In Q4 FY2022, CAD was $13.4 billion, or 1.6 per cent of GDP.

The RBI said the sequential decline in CAD in Q4 of fiscal 2022-23 was mainly on account of a moderation in the trade deficit, from $71.3 billion in Q3 of FY2022 to $52.6 billion in the fourth quarter, coupled with robust services exports.

Remittances, which are the second largest major source of external financing after service export, also contributed to narrowing the CAD. During the quarter, private transfer receipts, mainly representing remittances by Indians employed overseas, increased to $28.6 billion, up 20.8 per cent from their level a year ago.

Terms of trade relief from a correction in commodity prices, strong service trade and resilient remittances helped to narrow CAD in Q4 FY23 compared to the quarter before, said Radhika Rao, Senior Economist, DBS Group Research.

In the quarter, net foreign direct investment (FDI) was $6.4 billion. Net foreign portfolio investment (FPI) recorded an outflow of $1.7 billion in Q4 FY23, compared with an outflow of $15.2 billion in the year-ago quarter.

In Q4 FY23, there was an accretion to the foreign exchange reserves (on a balance of payments (BoP) basis) to the tune of $5.6 billion as against the depletion of $16 billion in the same quarter of the previous fiscal.

What does a lower CAD reflect?

The current account deficit is essentially the difference between investment and savings. If a country runs a current account deficit, then it needs foreign savings to finance that gap.

“When the current account deficit is lower, less money is needed to finance the gap. It is also treated as a sign of the resilience of the economy. You are less vulnerable if you have a low current account deficit,” said Dharmakirti Joshi, Chief Economist, Crisil Ltd.

What happened to CAD in FY2023?

The current account balance recorded a deficit of 2 per cent of GDP in 2022-23 as compared with a deficit of 1.2 per cent in 2021-22, as the trade deficit widened to $265.3 billion from $189.5 billion a year ago.

“Narrow external imbalances in Q4 FY23 helped contain the FY23 CAD at 2 per cent of GDP, compared to market expectations for an over 3-3.5 per cent shortfall earlier in the year in the midst of the rally in global commodity prices,” DBS Group’s Rao said.

Will CAD narrow in FY24?

Experts believe the country’s current account deficit is likely to moderate in the current fiscal. External balances will benefit from lower commodity prices as well as a sharp pick up in portfolio flows in the April-June 2023 quarter which will help in offsetting slower exports.

“We expect further improvement on the back of lower commodity prices. Merchandise exports are expected to remain downbeat as global growth weakens. Overall, we expect CAD in the range of 1.2 per cent to 1.6 per cent of GDP in FY24,” Bank of Baroda’s Economist Aditi Gupta said.

A combination of lower CAD and stable or lower capital account will keep the rupee largely stable, she said.