The current account is concerned with a country's short-term transactions, or the difference between savings and investments. These are also known as actual transactions because they have a real impact on income, output, and employment levels in the economy through the movement of goods and services. Current Account is an important topic for the UPSC IAS Exam Economy Syllabus.

What is Balance of Payment?

• The balance of payments (BoP) records transactions in goods, services, and assets between residents of a country and the rest of the world over a set period of time, typically a year.
• The BoP has two main accounts:
  • the current account
  • the capital account
• Current Account: The current account keeps track of goods exports and imports, as well as trade in services and transfer payments.
• Capital Account: The capital account records all international purchases and sales of assets such as money, stocks, bonds, and so on. Foreign investments and loans are included.

What is a Current Account?

• The current account tracks the inflows and outflows of goods, services, and investments into and out of a country.
• If the value of goods and services imported exceeds the value of those exported, the country runs a deficit.
• The current account includes net income, such as interest and dividends, as well as transfers such as foreign aid.
• The current account of a country keeps track of the country's transactions with other countries.
• The current account is made up of visible trade (goods exported and imported), invisible trade (services exported and imported), unilateral transfers, and investment income (income from factors such as land or foreign shares).
• The credit and debit of foreign exchange from these transactions are also reflected in the current account balance.
• The resulting current account balance is approximated as the sum total of the balance of trade.

Balance on Current Account

• Receipts from exports of goods, services, and unilateral payments are recorded as credit or positive items in the current account, while payments for imports of goods, services, and unilateral payments are recorded as debit or negative items.
• The current account balance is the net value of credit and debit balances.
• A current account surplus occurs when credit items exceed debit items. It represents the net inflow of foreign exchange.
  • For the first time in 17 years, India's current account in the balance of payments finished in a surplus of 0.9 percent of GDP in FY '21, as the trade deficit shrank due to a drop in pandemic-induced import demand.
• A current account deficit occurs when debit items exceed credit items. It denotes the net outflow of foreign currency.

Balance of Trade

• The balance of trade (BOT) is the difference between a country's imports and exports for a given period and is the most important component of a country's balance of payments (BOP).
• A trade deficit occurs when a country imports more goods and services than it exports in terms of value, whereas a trade surplus occurs when a country exports more goods and services than it imports.

Difference between Balance of Trade and Current Account

Components of the Current Account

The major components of the current account are as follows:

Visible Trade (goods exported and imported)

• The majority of foreign trade transactions involve a country's export and import of goods.
• Payments made for the import of goods from other countries are shown on the negative side or as debit items, while receipts from the export of goods to other countries are shown on the positive side or as positive items.
• The difference between these exports and imports is referred to as the trade balance or the merchandise trade balance.
• If imports exceed exports, the trade balance will be negative; if exports exceed imports, the trade balance will be positive.

Invisible trade (the export and import of services)

• It includes the export and import of services such as information technology services, banking, insurance, and consultancy services provided to foreign countries, BPO, tourism, and outsourcing, among other things.
• The export of services is recorded as a credit in the current account, while the import of services is recorded as a debit.
• Because the export and import of services are both invisible, they are referred to as invisible trade.

Transfer Payments

• Transfer payments are one-way transfers that include gifts and donations, personal remittances, foreign aid, charitable donations, withdrawal of NRI deposits locally, and so on.
• Incoming transfers are recorded as a credit to the current account, while outgoing remittances are recorded as a debit to the current account.

Net Factor Income

• Net factor income refers to income from foreign investments, profits from subsidiaries of companies located abroad, interest earned from loans and investments abroad, dividend income from shares in foreign companies, and so on.
• If income is received from foreign sources, it is recorded as a credit to the current account; if payments are made to foreign residents, they are recorded as a debit to the current account.

Remittances

Remittances have a positive impact on economic growth by reducing the current account deficit, improving the balance of payment position, and reducing reliance on external borrowing.

Current Account Deficit

• When an economy runs a current account deficit, it consumes more than it produces (consumption = domestic consumption + investment + government spending).
• This can only happen if other economies lend their savings to it (via debit 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 if 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.

Measures to Fund Current Account Deficit

• Current-account deficits are funded by a variety of capital inflows, including portfolio investments, external commercial borrowings, foreign direct investments, and NRI deposits. Inadequate financing for CAD may put pressure on the local currency.
• Non-debt creating long-term inflows, such as foreign direct investment, are the best way to fund the current account deficit. Volatile inflows, such as portfolio investments, or "hot money," could jeopardize the external sector balance sheet's stability.
• The Current Account Deficit in India could be reduced by increasing exports and reducing non-essential imports such as gold, mobile phones, and electronics.

Conclusion

After being surplus for some time, India's current account deficit has recently widened. At the same time, insufficient capital inflows have resulted in a significant weakening of the rupee against the US dollar. Because there is little that can be done to reduce the current account deficit while import prices are rising and exports are not increasing, a CAD of no more than 2.5 percent of India's GDP is deemed prudent. The government's task is to devise policies that will increase exports while reducing unnecessary imports such as gold imports.