Expect nothing, live frugally on surprise.

Saturday, October 25, 2008

Is current account deficit worrying?

The current account for Q1 2008-09 was noted at a deficit of $10.7 bn. This is the highest quarterly current account deficit (CAD) since the quarterly figures have been available (Q1 1990). The 1991 crisis was a result of the inability to finance the CAD. So, is the current CAD a cause of concern? Current account shows the external trade position of an economy. It comprises two sub-accounts — export/import of goods and export/import of invisibles. Invisibles include services, remittances and investment income. The goods imports have always been more than exports, resulting in trade deficit. Recently, goods imports have surged mainly due to high oil prices. The widening trade deficit so far has been negated by a surge in revenue from services inflows (software). If the service inflows are less than trade deficit we get CAD, which in turn is financed by capital inflows (FDI, FII, etc) from abroad (vice-versa for current account surplus). In Q1 2008-09, the trade deficit was $31.6 bn and the net service inflows was positive $20.9 bn, implying a CAD of 10.7 bn. Capital inflows were $12.9 bn leading to an overall surplus of $2.2 bn. The concern is not having a deficit, but financing it. In India, a widening CAD has so far been financed by buoyant capital flows. But things are expected to change looking at the current global crisis. First, pressure on oil prices is likely to continue as emerging economies expand further. Second, software exports are likely to decline tracking collapses of several foreign financial firms. The Indian software industry derives majority of its revenues from foreign financial sector and latter is clearly contracting. Third, with a global slowdown the capital inflows are also expected to decline Fourth, the goods exports are also expected to decline, as demand in other economies contracts. In all, CAD levels are expected to decline but the deficit is likely to continue. The silver lining is the ample forex reserves held by the RBI. Those would help India finance its oil bills and manage the global slowdown. The 1991 situation is not going to be revisited unless something dramatic happens. But there is no room for complacency.

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