Current Account Deficit (CAD) is one of the primary
components of balance of payments the other being the capital account. The
current account deficit is referred to when a country’s total imports is higher
than the total exports. Current Account Surplus (CAS) is just the opposite
where the exports are higher than the imports. The former of the balance of
payment make a country a debtor to the nations which it has trade relationship
and the latter a creditor to other nations. Obviously, now you know that a
surplus in current account is good and a deficit being really bad for a
country. This is one of the important macroeconomic indicators that describe
the state of a nation’s Balance of payments (BOP) and foreign exchange
reserves. In the age of globalization where each country has a significant and
potential role in international trade and finance, this indicator is crucial in
understanding a nation’s foreign exchange reserve and trade account.
India entered into the globalized world in 1991 with the
effect of New Economic Policy. The new economic reform was initiated by the
then finance minister Dr. Manmohan Singh which helped India to come out of a
serious Balance of Payment (BOP) crisis. The policy was and is still considered
as a milestone in the history of Indian economic reform. The reform not only saved
India from a severe bop that was threatening but also paved way to a new world
of globalization. The important concept under the new economic policy was
liberalization, privatization and globalization what came to be shortly known
as LPG. Before 1991 India had many restrictive trade
barriers and did not support much trade related activities. The policy
introduced liberalization which freed those trade barriers and encouraged world
trade and practices. India by signing General Agreement on Trade and Tariff
(GATT) soon became an emerging global hub of international trade. Privatization
is encouraging private players. Many public sector companies were changed
partially to private sector and India started encouraging many private sectors
entering into the playing field. Globalization is the result of liberalization
and privatization. India opened its hands to the global world encouraging
international trade and foreign investment like Foreign Direct Investment (FDI)
and Foreign Institutional Investment (FII).
The highlights of the policy were noteworthy and significant
in the development of India in many aspects. Prime Minister Manmohan Singh
being an economist exactly knew where the economy was heading and the dangers
in the long run and thus with much thought would have introduced the new
economic policy. The policy was applauded by many industrialists and people
from both within and opposite party. But the same man now has no idea of what
is happening to our economy, maybe, he knows but sitting ideally with no option
than listen to what Sonia Gandhi has got to say. Though this may sound rude to
some who are in favor of politics but this is the case in the past few years. For
those who have a high regard of the Indian political and administration system,
the so called “Indian patriotism” I would like to tell that its not the
defensive trait you have within you that supports the system but it’s the
feeling of what others think about India, which is not nationalism but
narcissism. Then why a man with such great caliber was able to save the economy
from a crisis in 1991 but not now? The point to be noted here is he saved our
country when he was a finance minister but now being a prime minister which
means he has more power and experience couldn’t do anything much to save the
economy from a brink of a crisis. Of course, I understand that our economy has
undergone several structural changes and India now is not the same India when
it was in 1991. And thus the same old tonic cannot be offered now to save the
economy. Moreover now its even more difficult as we are exposed to global
shocks and crisis. But there must sure be a way to solve the present problems
whatever may be the situation but the only thing I am concerned and trying to
reiterate here is that every day we have been seeing new problems but the existing
old problems being untouched or even ignored. One of the serious problem India
is facing today is the ballooning CAD. Though our economy has grown leaps and
bounds since 1991 it is the same problem we face today that we faced in 1991. The
high CAD is of a big concern and finance minister and other government officials
have been making statements to reduce it
if not at least control it. What are the steps they have taken in this
regard? Do they seem to be efficient and produce the desired results?
The Current Account Deficit (CAD) touched a record high of
6.7 percent of Gross Domestic Product (GDP) in the third quarter of the last
fiscal (October-December). This created
panic among some individuals but the policymakers seem to be not surprised by
the figure because in the past few months all economic indicators have pointed
to rise continuously, though the magnitude have been beyond imagination.
Holding this upward trend there have also been poor policy responses to meet
the problems. The finance minister said and promised to bring the CAD to 4.8
percent of GDP by the end of this fiscal which is still high but not alarming.
The CAD has been funded through capital inflows and not through the foreign
reserves which is a good sign. Infact in last few months there have also been
increase in the reserves. Though this is good to hear the CAD is still high
which is really unacceptable and much beyond actual RBI forecast of 3 percent
of GDP. No wonder this high CAD has seldom caused so much concern. Another way
to calculate the CAD is the merchandise trade deficit plus or minus invisibles
from net earnings from services. The primary reason for the widening CAD is the
large merchandise trade deficit. The large imports of oil, gold and silver have
been the main contributor. Since the global crisis the exports have been
constant or sometimes declining but the merchandise imports continue to increase
sharply. The lackluster performance of the net receipts and net invisibles has
helped the balance of payments but has added to the pressures. The dependence
on short term capital flows to bridge the gap and finance the CAD is dangerous.
According to RBI, the pickup in capital inflows was mainly due to foreign
portfolio investments. Foreign direct investment, by far the most desirable
investment flows declined in the third quarter of previous fiscal. The government
has been taking several strategy based policy decisions that could help the
environment conducive for short term capital flows. The finance minister in the last few months has asked the people of India to control their passion for
gold. He raised the import duty of gold in the last budget to reduce the demand of the yellow
metal which has been the main component in widening the CAD. The fall in gold
and commodity prices will reduce the current account deficit but they are not
the real solution. He has planned to introduce Inflation Indexed Bond (IIB) in
this fiscal year to curb the demand for gold and encourage investments that
could well be used as a hedge against inflation. He also encouraged investors to invest in mutual
funds by raising the limit through Rajiv Gandhi Equity Savings Scheme. The following graph shows the CAD, export and import as a percentage of GDP in the last thirteen years.
Anyway it is the job of the finance minister to hold out
hope. The marginal propensity to import by borrowing money in India is small.
People borrow more money when the interest rates are low and they then spend.
Some of the extra spending gets translated into imports. Without imports, the
extra demand would get translated into higher prices. India being India, we
have both inflation and higher imports. And add to lower exports and what we
have is something very worrying, a looming balance of payments crisis.
Government should control fiscal deficit no matter what the goals are, to achieve
long term sustainability. The big bang reforms of 1991 happened because the
government then was much more tempted by short term political pay offs rather
than long term sustainability. The current set of reforms is also happening
because a crisis is looming. A revival in exports depends on the economic
conditions in USA and Europe. There is not much India can do about it. But
financial incentives for export promotion can help in a long way to reverse and
improve the scenario. In the 22 years since the last major crisis, the economy
is right back where it started. One should know that two decades ago, Manmohan
Singh started off by getting the economy out of a very deep trouble. Now he
seems to end his career by landing it right back into it.
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