Current Account Deficit: Why it has become a key economic data?

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oi-Ambari

By Ambari Datta Gupta

Published: Tuesday, June 17, 2014, 14:20 [IST]

In an open economy, a country trades with another country i.e. imports as well as exports goods and services. When the value of the goods and services a country imports exceeds the value of goods and services it exports then it is called Current Account Deficit (CAD). So, CAD is typically the measure of a country's foreign transactions and hence a country's key economic data. It can be shown as follows:

CAD => Value of goods and services in import > Value of goods and services in export

Apart from the value of goods and services a country imports or exports, CAD also constitutes

* Net income (interest and dividends)

* Transfers (foreign aid)

The contribution of net income and transfers is of a very small per centage compared to the import and export of goods and services. Therefore, the major component of CAD is trade deficit. Trade deficit occurs in an economy when imports exceeds export for a given period of time. To know more about Trade deficit click here.

CAD can be reduced if the country starts increasing the value of exports compared to its value of imports. By implementing tariffs or quotas on imports can restrict imports. It can also use monetary policy to improve the valuation of the domestic currency compared to foreign currencies by the method of devaluation. This method, however, will make the country's export less expensive.

In the Indian context, a high CAD is bad for its economy. In FY13, India's CAD increased causing a worry, including potential threats of a sovereign rating downgrade by rating agencies.

High CAD puts an inflationary pressure on the value of the rupee. Therefore, the rupee witnesses a sharp fall when CAD rises.

Consequently, the government of India put restrictions on gold imports to prevent a worsening of the Current Account Deficit.

India's exports increased to double digits for the first time in seven months in May 2014. CAD in FY2014 narrowed to $1.2 billion from $18.1 billion in FY2013. According to RBI, the lower deficit was mainly due to lower trade deficit as imports fell sharply compared to exports. The declining trend in merchandise imports backed by drop in gold imports resulted in the contracting merchandise trade deficit.

However, the crisis in Iraq made unfavorable impact in global crude oil and rupee remains a concern.

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