Growing Current Account Deficit a Serious Concern for India
Posted: 12 May 2020
Date Written: June 1, 2019
Abstract
India has shown spectacular growth in its external sector during the decade of ‘90s in the post liberalization period just after the massive shock of Balance of Payments Crisis in 1990-91. The Current Account Deficit (CAD) position as well as the Balance of Payments (BOP) situation has shown gradual improvement and thereby India achieves the Current Account Surplus in 2001-02 to 2003-04 periods. However, after 2003-04 Current Account situation started to deteriorate again and consequently CAD has started to grow. We know that Capital Account Surplus finances Current Account Deficit to keep the Balance of Payments in balance. If the Capital Account Surplus is higher than the Current Account Deficit, Balance of Payments is in surplus which means an increase in foreign exchange reserves. If the opposite happens then BOP is in deficit and that means a decrease in foreign exchange reserves. Now since 1990-91, Current Account Deficit has remained below Capital Account Surplus for most of the periods up to 2007-08. Within this period of 1991-2008, during 2002-04, Current Account is also in surplus along with Capital Account. So there was no worry of BOP destabilization and BOP is in surplus in general and there occurred a cumulative accumulation of foreign exchange reserves for India. But after 2004, the CAD has started to grow again. More alarmingly, since 2008-09, Capital Inflow has shown a sudden fall. Although it has improved in later periods, but by not enough amount to cover up the growing CAD in a sustained basis. Obvious result has become the BOP deficit and depletion of foreign exchange reserves. Thus to control the BOP deficit and cumulative depletion of foreign exchange reserves, the major policy objective is now oriented towards getting rid of growing CAD that has become almost 5 percent of GDP in 2012-13. In the present study, our query is: Is Depreciation of Rupee a panacea for unmanageably growing CAD (or Trade Balance) for Indian economy in the long run? We have done an econometric study to find out the result. The result indicates to the fact that the automatic mechanism of depreciation is not observed to work well in Indian case. Rather, increased diversification of exports and control over imports seems to be the effective policy over the medium and long run for the government.
Keywords: Trade Balance, and Real Exchange Rate, Real Effective Exchange Rate, Real Depreciation, Unit Root Test (KPSS), Cointegration Study, FMOLS Method.
JEL Classification: C22, F41, O11, O24, O50
Suggested Citation: Suggested Citation