The recent report of a significant decline in India’s current account deficit (CAD) has brought much relief regarding the nation’s macroeconomic fundamentals, especially concerning the external sector. India’s CAD has fallen sharply from 2 percent of the gross domestic product (GDP) in October-December 2022-23, to 1.3 percent in July-September 2023-24, and further down to 1.2 percent in October-December 2023-24.
The CAD and current account balance, though not variables that monetary policy authorities or the government explicitly use to influence the economy, are crucial indicators for measuring the external balance of a country. In India, the fixation on CAD can also be attributed to the perceived impact it might have on the rupee-dollar exchange rate. A rising CAD is associated with the spectre of depreciation and costly macroeconomic adjustments.
What accounts for the falling CAD and is it time for India to rejoice for managing the external sector well? The current account, simply put, refers to the transactions that residents of India have with those of the rest of the world in terms of goods, services and incomes. These transactions encompass not only exports of gems and jewellery and import of oil and gold, but also include amounts spent by Indian tourists abroad, software service exports, and other service-related transactions. The current account also comprises investment income payments and remittances of Indians living abroad.
The trade deficit on account of goods has marginally increased by 0.4 percent year-on-year between Q3 2022-23 and Q3 2023-24. However, a closer examination of the data for 2023-24 reveals less encouraging figures. The trade deficit has surged by 26 percent between Q1 2023-24 and Q3 2023-24. Another critical component of the current account is the outgo on the primary income account, which has worsened by about 4 percent year-on-year between Q3 2022-23 and Q3 2023-24, but by 27 percent between Q1 2023-24 and Q3 2023-24.
A meticulous analysis of the trade deficit for 2023-24 unveils significant trends about imports of goods. Firstly, imports of both oil and non-oil have gone up between Q1 2023-24 and Q3 2023-24, driving an overall increase in goods imports. Secondly, the proportion of oil to total imports in each quarter has remained at approximately 26 percent. Thirdly, non-oil imports are nearly 2.8 times the oil imports in 2023-24.
Further dissecting non-oil imports over the past years (since granular data for 2023-24 is unavailable) from 2018-19 to 2022-23 reveals a steep increase in the imports of certain goods. Thus, imports of vegetable oil surged by 110 percent, fertilisers, crude and manufactured goods by 130 percent, and electronic goods by 34 percent, while gold imports—often vilified for India’s Balance of Payment woes—experienced only a 6 percent increase over the period.
It is the rising exports of software, business and travel services, and other service exports, that have grown by 5.2 percent on a year-on-year basis, which have helped bridge the gap caused by the trade deficit. Such service balance (net services) has surged by a substantial 28 percent between Q1 2023-24 and Q3 2023-24.
However, the payments toward imports of services reveal another intriguing detail. Payments toward the service item labelled “other personal, cultural, and recreational services” have ballooned by 284 percent, from $94 million in 2018-19 to $362 million in 2022-23. Ensuring expenditures on marriages are made within India could significantly reduce these substantial payments and outflow of precious dollars, besides saving on the travel item as well.
Another cushion available for the current account balance has been private remittances by Indians working overseas. These remittances have grown by 2.1 percent on a year-on-year basis in Q3 2023-24, but by over 16 percent in 2023-24.
An intriguing revelation stemming from a granular analysis of payments related to invisibles is that private transfers from India have skyrocketed by 84 percent over the period from 2018-19 to 2022-23, surging from $5,795 million to $10,689 million.
Thus, while the reduction in the CAD itself may give us much-needed solace from a persistently high CAD, especially in the wake of the global financial crisis, it is important to understand how individual items of the current account balance are moving, and the quality of the CAD itself, besides sustainability of such a reduction. As the adage goes, the devil lies in the details, and a more nuanced understanding may be required to ensure a more sustainable and robust current account balance.
Policy makers must heed the shifting significance of items contributing to the new trade deficit. Could industries that dominate the list of new chartbuster imports be prioritised for substantial support/push through policy measures? Moreover, could established, large industries collaborate with India’s vibrant startup ecosystem to foster innovation aimed at developing import substitutes? Simultaneously, the escalating trend of service payments by Indians to non-residents would necessitate a different outlook.
It would be beneficial to examine history and recognise India’s external payment crisis in 1991 primarily stemmed from an adverse invisibles balance, driven by a significant increase in investment income payments (debt servicing) and a decline in remittance receipts. While India has come a long way since, a cautious approach towards external sector management would continue to be the most advisable strategy.
(Views are personal)
(tulsi.jayakumar@spjimr.org)
Tulsi Jayakumar | Professor, finance and economics, and Executive Director, Centre for Family Business and Entrepreneurship at Bhavan’s SPJIMR