About Current Account Deficit (CAD)

About Current Account Deficit (CAD)

  • The current account measures the flow of goods, services and investments into and out of the country.
  • A country runs into a deficit if the value of the goods and services it imports exceed the value of those it exports.
  • The current account includes net income, including interest and dividends, and transfers, like foreign aid.
  • It indicates a country (say India) is borrowing and is net debtor to rest of the world.
  • Depending on why the country is running the deficit, it could be a positive sign of growth, or it could be a negative sign that the country is a credit risk.

 

Consequences of the Current Account Deficit

  • A deficit in the current account leads to depletion of foreign currency assets as these assets are used as a source to fund deficit which forms part of capital account.
  • Depletion of foreign currency assets reduces money supply which in turn results to liquidity issues.
  • High imports results in higher demand for dollar causing rupee to weaken (rupee depreciation) which in turn impacts liquidity.
  • In the long run, a current account deficit can sap economic vitality.
  • Foreign investors may begin to question whether economic growth can provide an adequate return on their investment.
  • Demand could weaken for the country’s assets, including the country’s government bonds.
  • As this happens, the national currency will gradually lose value relative to other currencies.
  • As the value of its currency declines, the value of the foreign assets rise, thus further reducing the current account deficit.
  • The consequences of a current account deficit can be a lower standard of living for the country’s residents.

 

Way forward

  • As, the central bank wants to see the current account gap within 2.5% of the GDP, which is seen as crucial for currency stability, it should intervene and control depreciation of currency.
  • Import of unnecessary items can be reduced.
  • Import duties can be increased.
  • Exports can be increased to maintain foreign currency reserves.
Section : Economics

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