India’s Current Account Deficit (CAD), one of the key economic metrics, is blinking red. It widened sharply to 2 per cent of GDP during the December quarter, up from 1.4 per cent last year owing to rising merchandise imports. Experts warn that high imports can weaken the rupee, sap liquidity, turn away foreign investors and slow down demand like it did in the past, when deficit ballooned to an all-time high of 4.8 per cent in FY14. CAD alone isn’t life-threatening, but a combination of higher CAD, fiscal deficit and inflation will lock the gates to the sunlit uplands of growth and prosperity.
India had a good run when crude prices were in free fall. But now the champagne is back on ice and economists expect the deficit to widen to $55-60 billion in FY19 on firming crude prices as every $1 increase in crude basket bloats CAD by $1.3 billion. What we didn’t see coming though is the increase in US trade tariffs sparking a global tariff war and risking global trade. Back home lurks another danger with exports of gems and jewellery, which usually depends on demand, staring at a potential funding crisis in the aftermath of the PNB fraud.
CAD isn’t necessarily a bad thing. Developing countries run deficits in the short-term to increase local productivity and exports, but in the long run, it worsens credit risk. A deficit implies that the government is a net debtor to the rest of the world, that its economy is investing more than saving and is using resources from other economies to meet its consumption and investment needs.
Exchange rate depreciation and/or improved competitiveness can correct deficit imbalance, but much like spilled water that can’t be picked up, if left unattended, widening CAD can drain economic vitality, weaken demand for government bonds, raise yields and erode currency value. Only a mix of good policy (import tariffs and export promotion) and perhaps good luck (lower crude prices) can turn around the deficit from the depths of despair.