Current

Account Deficit
By Group No 2

Akshay Jayaprakasan
Anirudh S.
Anuradha Dhote
Aparna Goswami
Apurba Roy Chowdhury
Aseem Agrawal
Current account deficit the larger picture
Balance of
payment
Capital
account
Current
account
Capital account
Reflects net change in
ownership of national
assets
Includes FDI, Portfolio
investment, Other
investment, Reserve
account
Current account
Balance of trade
Factor income(interest
and dividends from
international loan and
investments
Net transfer
payments(e.g. Foreign
aid)
BoP is a statement that summarizes an
economys transactions with the rest of the
world for a specified time period. The
balance of payments, also known as balance
of international payments, encompasses all
transactions between a countrys residents
and its non- residents involving goods,
services and income; financial claims on and
liabilities to the rest of the world; and
transfers such as gifts.
Components of CAD
A major component of CAD consists of trade deficit
Y = C + I + G + NX
NX = Y (C + I + G )
NX = (Y C G ) I
= S I
trade balance = net capital outflows
NX = Exports - Imports
NX = Saving - Investment

CAD trends
CAD balance (Quarter-wise)
CAD as % of GDP (Quarter-wise)
CAD crisis
Why is there a crisis?

Hence, CAD, along with a high trade deficit puts pressure on the currency and poses a
thread to growth macroeconomic stability

Of late, with restrictions on gold imports and strong measures to address rupee
depreciation, CAD is expected to improve dramatically. However, this comes after CAD
ballooned to 4.8% of the GDP or, $88 billion, in the year 2012-13

Hence, we need to understand CAD, its associated causes and consequences so that it
can be sustained at moderate and predetermined level in the long run

Causes of a high CAD
Changes in exchange rates: As the exchange rate determines a countrys foreign trade, it also affects CAD.
Assuming demand for exports is relatively elastic then a depreciation will lead to an increase in the value of exports
and therefore improve the current account deficit. However, in practice this may not happen due to elasticity if
demand, profit margins and global demand. Depreciated currency also attracts less foreign investment leading to
decrease in capital investment

Changes in income: When people can afford to buy more goods, increased consumption may lead to increased imports

Less competitiveness: The economy becomes less competitive leading to decrease in exports, hence an increased CAD.

Recession in other countries: Major trading countries such as US & EU have experienced recession leading to a
reduction in import of our goods adding to CAD.

Debt: To finance deficit and current account the government has incurred high debt while CAD has exacerbated

High Imports: Due to rising prices in gold and oil imports with very little decrease in demand of them, the import bill
has remained high which is a cause of concern

Government spending: Increase in government spending leads to twin deficit, both fiscal and trade deficit.

Economic models
Mapping trade
deficit a
component of
CAD - on the IS
model
Economic models
Exploring
increase in
government
spending -
leading to fiscal
deficit and trade
deficit
The Marshall-Lerner
condition
Condition under which a real
depreciation (a decrease in )
leads to an increase in net
exports.

The depreciation leads to a
shift in demand, both foreign
and domestic, toward
domestic goods. This shift in
demand leads in turn to both
an increase in domestic
output and an improvement
in the trade balance. The
magnitude is more in this
case than the increase in
foreign demand.

Statistical Models
India is a huge oil importer
constituting a major portion
of imports.
It significantly contributes to
trade deficit.
Hence, correlation between
oil prices and trade deficit is
positive as can be seen from
the scatter plot.
Statistical Models
Indians invest significantly in
gold assets.
Until the recent curbs on gold
import , it constituted a
significant portion of
widening CAD.
Hence, positive correlation
between gold prices and
trade deficit can be seen from
the scatter plot.
Causes of a high CAD
Taking a new perspective
structural causes
Measures like curbing gold imports to reduce
CAD are only short-term and temporary, and
bound to have undesirable side effects, for e.g.
Increase in smuggling.
Imports looking away from gold and oil
India has the third largest coal reserves in the
world, and yet imported 135 million tonnes in
2012-13.
No domestic production capacity has been created
in the fertilizer sector for some two decades. This is
despite the fact that import sector is given a huge
subsidy















Causes of high CAD
Taking a new perspective structural causes
Unsustainable measures to reduce CAD
To address high CAD and its consequences like , currency depreciation, the government takes
measure to attract dollar inflows in the country, often by means to incentivising corporate to
increase External Commercial Borrowing. As more capital flows in, it increases debt burden
and shifts macroeconomic focus from trading to non-trading activities, thus further increasing
CAD
External reserves build-up as a result of capital inflows, which is also used to finance the CAD,
rings an unhealthy trend in the economy

Taking a new perspective structural causes
Let us look at CAD from the perspective of economic cycles. As per recent report by
Indira Gandhi Institute of Development Research Indian CAD is counter cyclical i.e.
It rises when output falls, and not when
In 2011-12, CAD reached 4.2% of GDP, while in the same year GDP growth rate fell to 6.4%.
Growth in aggregate demand like consumption and fixed investment also fell from 5 to 8%.
However, in all other emerging markets CAD tends to be pro-cyclical, rising with
overconsumption
In 2007-08, during high consumption, investment and output growth, CAD was 1.3%
External supply shocks affect CAD more than excess
demand factors
Collapse of export markets due to global factors > reduced income > CAD widens
Oil shocks > increased costs > reduced growth > CAD widens
Uncertain effect of depreciation
Delayed depreciation effects
Negative exports growth in 2012-13, while currency depreciated


Causes of high CAD
Twin Deficit
Budget Deficit Trade Deficit
Government Spending

Interest rate Consumption

Capital Account Current Account
Surplus Deficit
Changes in the Economy
Consequences of Current Account Deficit
LOSS OF FOREIGN RESERVES

We loose reserves in the form of payments for the goods and
services being imported and also the money borrowed from
the foreigners needs to be repaid and that leads to loss of
foreign reserves in addition to that.

IMPACT ON EXCHANGE RATE
Due to increase in the exchange rate Foreign capital starts flowing in the
economy which would increase the demand of domestic currency
Currency Appreciation

But if the inflow of funds is not enough to fund the deficit, then the
currency of the economy starts to DEPRICIATE with the concerns that
the country will not be able to fund its current purchases.

DEPENDENCE IN FOREIGN INDUSTRIES

So if the foreign industries take a hit that also has an impact on the
domestic eonomy
Extent of CAD
It depends on how much capital flows a country can
attract. So when a country needs money to finance its
Current Account Deficit it tries to make the economy
an attractive destination for foreign investors
Sustainability of CAD
The current account deficit is funded by inflow of foreign funds in the
economy


INFLOW
OF
CAPITAL
CAPITAL
INVESTMEN
T
CAPITAL
FLOW
Capital flows Can be either long term or short term Eg. FIIs It creates
vulnerability in the economy as it puts an upward pressure on the
interest rates to attract capital flows

Capital Investment Long term investments
Eg. FDIs
Iceland Crisis
Iceland is an example of a country with a large current deficit which
later imploded. In the years leading up to 2008, there was a sharp inflow
of capital to Icelandic banks. This enabled Iceland to run a record
current account deficit. Iceland was spending more than they were
earning. When capital flows dried up, banks lost money and there was a
rapid deterioration in the current account.
CAD Good or Bad?
GOOD BAD
CAD is sustainable and thus good,
if it is being funded by long term
investments rather than short term
investments
But selling long term assets to fund
short term consumption,
undermines future production and
in that CAD is bad

Also if the CAD exits to meet the
curent consumption needs, instead
of long term investments then its
bad

Reason why CAD should be funded by long term funds
is that short term funds or HOT MONEY causes
vulnerability in the economy and if suddenly the funds
are pulled out it causes a LIQUIDITY CRISIS in the
economy.
Innovative ways to reduce CAD
Increase country-specific bilateral trade, for e.g. with China in view of increasing Chinese
wages and their new economic policy to move away from export-led growth
A long-term solution to the problem cannot be one of borrowing more (through state-
guaranteed foreign debt incurred by public sector companies for example) or of wooing
foreign investors and attracting more foreign capital.
A sharp reduction in gold imports is what the Government needs to aim for. And if recent
experience is any guide, raising duties on gold imports does not seem to help much; indeed
it seems to increase imports by those speculating that duties would rise even more.
Stringent quantitative restrictions on the volume of permitted gold imports are a must.
Quantitative restrictions on those imports that are not only non-essential, but whose
substitution could help the economy to regain crucial production capacity and with it, the
elements of manufacturing potential.
Diversification of the export basket and the destinations they go it, improvements in
domestic supply conditions, and overall global demand conditions are more reliable export
boosters than depreciation.
Discussions
Part 1
Flashback of CAD
1991 Economic crisis

What lead to the crisis?

Large and growing fiscal imbalances over 1980s

Spill over effect on trade deficit

External payments crisis
Discussions
Part 2
What causes CAD ??
1.QUALITY OF IMPORTS

An economy that is growing at a faster rate than other nations has high imports
and usually runs a current account deficit.
If a country imports more capital goods, it means there is an increase in the
economic activity. Companies import capital goods equipment only when they
expand capacities.
However, Indias imports primarily include oil and gold. These two commodities
do not help any manufacturing and export growth.
Indias oil imports rose despite an overall economic slowdown. India also
continued to import gold as demand stayed high. This was despite the additional
duties imposed on import of gold.
Recently another worrying factor has been the sharp rise in coal imports and
steep fall in iron-ore exports
OIL IMPORT IMPACT
Indias oil bill continues to
remain a major import item
owing to inelastic and growing
energy demand and rising
global crude oil prices due to
exogenous factors such as the
middle eastern geopolitical
situation and the Arab Spring
episodes.
Studies have shown that each
US $ 10 per barrel change in the
oil prices affects Indias CAB by
US $ 8 billion ( center for budget
and governance accountability)

GOLD IMPORT IMPACT
India accounts for 25% of the worlds gold demand. Share increased from US$ 33
bn (2009-10) to US$ 57 bn (2011-12)
Share of gold imports has increased from 7.6 % (2005-06) to 12.6% (2011-12)
Major reason believed to be global hike in gold prices post the sub-prime crisis,
gold seen as a safe haven
Demand spurt due to investment dynamics rather than historic affinity for
jewelry.
Further encouragement by Gold loan schemes granted by banking & non-banking
financial companies (gold loans worth Rs. 150000 Cr in 2012 as against 20000 cr
in 2008)
Additional benefits of saving in gold.



Rising gold demand due to various factors
has caused the CAD to worsen by causing a
very large trade deficit.
RISING COAL IMPORTS
Though the second largest producer of coal in the world,
Indias coal imports have seen a steady rise from 20 million
tones in 2001 to 130 million tones in 2012, causing a sharp
US$ 18 billion rise in the import bill.
With 60-70% of the countrys electricity demand being
catered by coal alone, further rise in future expected unless
large scale alternate energy source implementation isnt
done.

DISAPPEARING IRON ORE EXPORTS
Sharp fall in export of iron-ore from 117 mt in 2009-10 to 18mt
in 2011-12, India is now expected to become a net importer in
the current fiscal decade; adverse impact on CAD.

INSUFFICIENT SAVINGS
S-I =CAB
CAD implies that the savings available in the economy are not sufficient
to satisfy the investment made and this can be made up by external
capital (in the form of financial aids, stimulus packs, borrowing from
abroad).
Insufficient savings in the private sector- low income levels, high taxes
or high price levels
Insufficient government savings- higher expenditure on developmental
projects , welfare schemes, subsidy etc which do little to raise the
production/output.
OTHER FACTORS
uncompetitive exports
1) due to fixed exchange rates
2) due to inflation

Falling inward remittances
Restrictive legislations and policies
Recession in other countries, especially the trading partners


Discussions
Part 3
How to reduce CAD?
Import controls
A country can levy tariffs on
imports
This will lead to increase in price of
import goods.
So the demand for imports should
fall . This will be good for domestic
producers as well as helping the
current account deficit to fall.
Why it might not work ?
The foreign firm can
absorb tariffs and
balance out price
increase not a long
term option

WTO intervention- if
trade and tariff
agreement violated
WTO will intervene to
sort out differences.

A devaluation of the exchange rate
This involves reducing the value of the currency against
others.


The price of importing goods increases and the
quantity demanded of imports falls.
Exports will be become cheaper and there will be an
increase in the quantity of exports
assuming demand is relatively price elastic, we would
expect a devaluation to lead to an improvement in the
current account

Why it might not work ?
The resulting higher import prices lead to higher
inflation
Devaluation is the easy way out for exporters but is a
poor long term option.

governments avoid devaluation at all costs, even though
it makes industry more competitive
Supply Side Policies
Improve the competitiveness of the economy and
help make exports more attractive.

Benefits of Supply Side Policies
Lower Inflation
Lower Unemployment
Improved economic growth
Improved trade and Balance of Payments.
Various Supply side policies
1. Improving Transport and infrastructure
2. Deregulation of economy
3. Reducing Income Taxes.
4. Increased education and training
5. Deregulate financial markets
6.. Privatisation



Deflation
If a government reduces aggregate demand by raising interest rates or
increasing taxes then people will have less money to spend so they reduce
consumption of imports.

High marginal propensity to import so a reduction in AD improves the
current account significantly
Deflationary policies will also put pressure on manufacturers to reduce
costs and this will lead to more competitive exports and so exports will
increase



Discussions
Part 4
Recent News and Happenings !
India's current account deficit falls to $5.2 billion in
July-September quarter

Narrowed sharply to USD 5.2 billion
in the July-September quarter of
2013-14
1.2% of GDP
Decline in gold imports
Was USD 21 billion, or 5 per cent of
the GDP, in the second quarter of last
fiscal.
Expected CAD to be below USD 56
billion in the current fiscal compared
to the record high of USD 88.2 billion,
or 4.8 per cent of the GDP last fiscal
http://timesofindia.indiatimes.com/business/india-business/Indias-current-account-deficit-falls-to-5-2-billion-in-July-September-quarter/articleshow/26746231.cms?
Rupee to be fairly stable with CAD narrowing

From the macro viewpoint, the growth
trajectory seems to be fairly stable and
quite positive
From the viewpoint of the US being a
consumer of exports from many other
countries, it is fairly reassuring at this
point
Negative aspects of the US macro
environment are the risks associated
with a lack of reconciliation, both on the
budget and on the debt ceiling
Rupee depreciation is helping exports
grow and imports are contained
http://economictimes.indiatimes.com/opinion/interviews/rupee-to-be-fairly-stable-with-cad-narrowing-subir-gokarn/articleshow/26957325.cms
A fall in CAD does not mean a fall in gold
demand
India produces almost no gold of its own
Gold smuggling is a fairly lucrative
operation
Mumbai airport customs has seized
around 73kg gold worth Rs.19.71 crore
between April and October this year
Unofficial gold will continue to find its
way into the country to satisfy demand
http://www.firstpost.com/economy/a-fall-in-cad-does-not-mean-a-fall-in-gold-demand-1263991.html