Why is high Current Account Deficit (CAD) bad for India?

The ever-widening current account deficit is held responsible for several of the prevailing woes of the Indian economy including free fall of the domestic currency in the foreign exchange market, stock market crash, inflation and fiscal deficit. In fact, so far the rigorous steps taken by the government authorities in this direction have not come to the rescue of the ailing CAD figures.

However, it has been cited that the current account deficit which stood at US$ 38,973 million in the first half of 2013 would be tamed to 4.7% of nation's GDP by the FY'2014. Though, in the normal economic conditions, CAD figures of 2.5% of a nation's GDP is acceptable.

Let us now try to understand how the present figures of CAD have spooked the overall Indian economy. CAD that is nothing but the gap between inflow and outflow of foreign currency has risen even since the financial crisis of the US in 2008. The main reasons put forth by the finance ministry for the widening of the CAD are lower exports and higher degree of imports of oil, coal and yellow metal gold. As otherwise, high imports of capital goods and equipment reflect the growth in an economy that though is not the case with the Indian economy.

In order to keep the balance of payment intact, high CAD figures then have to be financed which thus increases the reliance on foreign funds or capital account. The Indian economy was safeguarded and in fact was at the mercy of the foreign capital which came in through FDI and FII. But global economic outlook which spares none of the economies has cast its effect strongly on India. The bond buying programme or quantitative easing (QE) measures that were undertaken by the US Federal Reserve in the wake of the sub-prime crisis of 2008-2009 is likely to be wind down as the economy has shown signs of recovery. What this means is that easy liquidity through QE measures would ensure that foreign institutional investors gradually pull off from the Indian markets, raising fresh worries for financing the CAD.

Moreover, surge in foreign funds outflow hit the domestic currency hard which slumped to record low levels of 64.13 against the dollar on August 19, 2013. Rupee slump or depreciation is in turn likely to put pressure on the fiscal deficit of the government as fuel bill is likely to be inflated with no signs of revenue growth as per Moody's view in The Economic Times report.

Also, in view of the worsening CAD figures, RBI's room to cut down key monetary rates has been limited which has left the problem of high inflation unchecked. High CAD figures and overall economic outlook also weighed on the capital markets that crashed by as much as 1.2%.

So, high CAD figures seem to have trapped the Indian economy in a vicious circle as warned by RBI Governor D. Subbarao in March 2013 "Should the risk of capital exit materialize, the exchange rate will become volatile causing knock-on macroeconomic disruptions". And only high net fund inflows and increase in export activities could save the crisis-ridden economy.

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