Current Account Deficit Likely To Be Lower At 3% This Fiscal: SBI Report (UPSC Current Affairs)

Relevance: GS3 - Indian Economy and issues relating to planning, mobilization, of resources, growth, and development;

(Source: The Hindu,11/11/22)

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Why in the news?

• A recent report by the State Bank of India said that in contrast to the minimum consensus estimate of 3.5% a reduced current account deficit for this fiscal year of 3% has been projected.
• The report has Cited increased software exports, remittances, and a potential USD 5 billion increase in foreign exchange reserves through swap arrangements.

Highlights of the report

• According to the chief economic advisor at SBI, every $10 increase in oil prices has a 40 basis point impact on the Current Account Deficit (CAD), while the same rise in fuel inflation has a 50 basis point impact and also leads to a 23 basis point fall in growth.
• The CAD has a counter-cyclical shock absorber.
• Exchange rates account for 40% of the fluctuation in software exports, which substantially contributes to their growth.
• If expressed in real terms, every Re 1 decline versus the dollar results in a $250 million rise in software exports.
• Combined with an anticipated $5 billion accrual of currency reserves from swap transactions and higher remittances, this will limit the Current account deficit share of the economy to 3% of GDP, down from the average lowest level projected for the year of 3.5%.
• As swap transactions reverse, the FX reserves, which fell from $642 billion in September 2021 to approximately $531 billion last week, are anticipated to increase by $5 billion.
• The largest influence on CAD comes from oil imports, which account for up to 30% of the nation's import bills. As a result, any increase in oil price directly affects the trade deficit by raising the cost of imports and widening the CAD.
• Software exports have been increasing, with the percentage of domestic IT services companies' offsite software exports rising to 88.8% in FY22 from 82.8% five years earlier.

What is the Current Account deficit?

• The current account tracks the inflows and outflows of goods, services, and investments into and out of a country. When the value of goods and services imported exceeds the value of those exported, the country runs a deficit.
• It keeps track of the country's transactions with other countries.
• When an economy runs a current account deficit, it consumes more than it produces (consumption = domestic consumption + investment + government spending).
• This can only happen when other economies lend their savings to it (via debt or direct/portfolio investment in the economy) or if the economy is depleting its foreign assets, such as its official foreign currency reserve.
• A rising CAD indicates that a country has become uncompetitive, and investors may be unwilling to invest there.
• A current account deficit isn't always a bad thing. A current account deficit is irrelevant when it is driven by the private sector because it is caused by private sector agents engaging in mutually beneficial trade.
• Current Account = Trade gap + Net current transfers + Net income abroad (Trade gap = Exports – Imports)

Significance of Current Account Deficit

• The current account deficit is a key indicator of competitiveness as well as the level of imports and exports.
• A large current account deficit usually indicates an economic imbalance that must be corrected through exchange rate depreciation and/or improved competitiveness over time.
• A current account deficit is paid for by attracting capital inflows, such as foreigners purchasing domestic assets. This means that foreigners have a stronger claim to assets and dividends.
• Because we are buying from abroad, the Current Account Deficit allows for higher levels of domestic consumption.

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Some Important FAQs

MCQs

Question: Consider the following statements:

1. The current account deficit is a key indicator of competitiveness as well as the level of imports and exports.
2. The current Account Deficit allows for higher levels of domestic consumption.

Which of the above statements is/are correct?

(a) 1 only

(b) 2 only

(c) Both 1 and 2

(d) Neither 1 nor 2