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Home / Opinion / Views /  What India’s current account deficit says about savings in the country

India’s current account balance or CAD turned negative in the September quarter at 1.3% of GDP, after being in surplus for all of FY21 and the first quarter of the following fiscal. So should we be worried about the deficit? No, and yes.

CAD is the result of all transactions in the current account; trade, software receipts and remittances determine the final aggregate. Of these three, the trade balance is critical as it has the largest share in the current account. Software receipts and remittances are positive and considerably high; they were at $52 billion and $38 billion respectively in the first half of FY22. Clearly, these are India’s strengths, although their growth depends on how the world economy performs. Software exports thrived during the pandemic. The sector was unaffected as the demand for anything virtual was doing well. Remittances come mainly from expatriate citizens and, while they did slow last year due to lockdowns in most countries, they have still been fairly strong.

Trade is the interesting part because even as we revel in exports growing 49% in the first nine months of the year, imports increased by 69%. When economies grow, they invariably import more and foreign trade flourishes. India’s exports benefited from precisely this phenomenon of other countries importing more. Imports have increased because the domestic economy is also growing, leading to a recovery in demand for imports. When non-oil imports increase, it is considered a good sign, as these goods are used partly as raw materials for producing higher levels of industrial output. Therefore, it is not surprising that while exports topped $300 billion in these nine months, the deficit more than doubled from $61.38 billion to $142.44 billion.

The CAD was negative for the first half of the year, at -0.2% of GDP, which is not a worry. The thumb rule is that countries need not worry as long as the CAD is less than 4% of GDP. However, red flags are likely to be raised once the CAD crosses the 2.5% level; raised higher once the 3% threshold is crossed. At those levels, the RBI is likely to examine whether any intervention is required to moderate the CAD. Normally as the CAD widens, the rupee tends to fall unless the capital flows—like FII and FDI—are robust.

Right now, there seems to be no cause to bother, as the current account balance of one quarter is showing a deficit of 1.3%. The deficit will likely continue in the next two quarters too though there can be a slowdown in the fourth quarter.

That, however, does not mean all is well with the economy. The current account deficit also tells us another story about the state of the macroeconomy. In economics, the current account balance is a mirror image of the savings-investment relation in an economy. When investments exceed savings, a current account deficit emerges. Intuitively, if we are investing without the backing of domestic savings, then the funds must come from outside. Therefore, ex-post, the savings minus investment number will be equal to the current account deficit. This relationship requires a closer look in the Indian context.

The anomaly in the CAD in the September quarter is that investment was not increasing as there were still conditions of uncertainty for the industry that was operating with surplus capacity. Debt issuances for investment were lower than in the previous year. So then, how could a deficit have arisen? The answer is that financial savings have taken a hit of late, with interest rates coming down to the extent that real interest rates are negative. Bank deposits are going out of fashion for this reason. Hence, we have a situation where the savings minus investment has given a negative number not because investment is increasing but because savings are coming down. That definitely is not a good sign for our economy and calls for quick measures aimed at ensuring improvements in incomes generation and savings.

 

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