Why a current account deficit is good for India
Summary
- India’s current account deficit for 2023-24 was the second-lowest in two decades. But moving towards a surplus isn’t necessarily great news, thanks to a sluggish savings growth and an imminent rush of foreign inflows.
India’s current account recorded a rare net surplus of $5.7 billion in the first quarter of 2024. That means more money entered the country than went out, helping India limit its deficit in 2023-24 to $23 billion, or 0.7% of GDP.
Barring the first pandemic year, the deficit would be a seven-year low and the second-lowest in two decades. That sounds like a reason to rejoice, but it’s more a call for caution.
One metric evaluates the current account through the difference between domestic savings and investments:If a country saves more than it invests, it runs a surplus; the opposite means a deficit. India’s massive investment needs cannot be met by the collective savings of its households, businesses and the government. That’s why it runs a deficit, usually 1-3% of GDP.
What changed in 2023-24? The Reserve Bank of India notes an uptick in investments, driven by higher government spending and bullishness in the housing sector. Given that rating company Crisil recently pegged investments at 33.7% of GDP in 2023-24, a 1.5 percentage point jump, that translates into a 33% savings rate for a 0.7% current account deficit. That’s also a significant rise.
Here’s the clincher: a rising savings rate also allows for greater investments while keeping the current account deficit at the same level. And if we run a modest 2% deficit, a 33% savings rate would mean an investment rate of 35%—or ₹6 trillion available towards nation-building. So even a deficit, when it’s the result of robust savings and strong investment, is guaranteed to boost growth.
Demography and deficit
In theory, India’s demographic profile is perfect for a high savings rate. A high, and increasing, share of the working-age population (that means fewer dependents such as the elderly and children) should push up production, income and savings.
A declining fertility rate should be accompanied by an increasing number of women in the labour force, adding an extra boost. This is the much-discussed demographic dividend, which pays off by raising labour strength and productivity.
But India’s savings rate hasn’t grown enough in recent years, for reasons ranging from inadequate job creation and poor skilling of labour to economic setbacks caused by demonetisation and the pandemic. That’s why the current rate of growth in savings is unlikely to be enough to fund the scale of investments India needs to support strong economic expansion.
That would result in a current account deficit: drawing on overseas savings will be essential to reap the demographic dividend.
Exchange-rate pressure
Meanwhile, India’s markets are favourably placed to receive foreign exchange inflows in the near term. The inclusion of Indian sovereign debt in two key global indices is expected to bring a sustained inflow of dollars.
India is one of the world’s fastest-growing economies, and with the uncertainty of the general elections over, investments that were on hold are likely to come in. If the US rate-cutting cycle starts before the year-end, as expected, a re-routing of global capital towards emerging markets, including India, is also possible.
Some of these factors are already priced in: the rupee has been one of the best-performing currencies this year in both nominal and real terms (basis the real effective exchange rate).
But given geopolitical frictions and the rise of protectionism, even a moderate appreciation (or relatively lower depreciation) in the rupee could make India’s exports dearer and hurt their competitiveness. A current account deficit at this point would counterbalance expected capital inflows and keep the rupee contained.
Good deficit, bad deficit
A current account surplus is not always good and a deficit not always bad. What matters is the quality of the deficit or surplus, which depends on its composition and sustainability.
A deficit driven by investment in sound projects with sustainable future benefits is good. A surplus created by unused savings created by the absence of domestic investment opportunities is bad. In India’s case, a deficit driven by surging gold imports is bad, as would be a surplus driven only by remittance inflows.
Half of the top 20 emerging markets have persistent current account deficits. The surplus countries are either oil-rich (Russia, Iran), export-oriented (China, Thailand, Korea) or rising export stars (Vietnam).
The lessons are obvious. Instead of labelling a deficit as good or bad, India needs to build export potential in the long term. Meanwhile, an institutional environment that attracts and absorbs foreign capital efficiently would fund moderate deficits in the short term.
The author is an independent writer in economics and finance.
