Current Account Deficit : An Indian Perspective

Submitted by :

Group 5
Aishwarya Kumar (PGP/16/063) Anirban Bhar (PGP/16/064) Anusha Acharya (PGP/16/071) Palak Bansal (PGP/16/097) Pratik Agrawal (PGP/16/101) Nimish Shah (PGP/16/110) Required as part of Term Project

AGENDA

Current Account An Introduction

CAD An Indian Perspective

Case Study 1 US CAD and the Financial Crisis

Case Study 2 Brazil : From Surplus to Deficit

AGENDA

Current Account An Introduction

CAD An Indian Perspective

Case Study 1 US CAD and the Financial Crisis

Case Study 2 Brazil : From Surplus to Deficit

AGENDA

Current Account An Introduction

CAD An Indian Perspective

Case Study 1 US CAD and the Financial Crisis

Case Study 2 Brazil : From Surplus to Deficit

AGENDA

Current Account An Introduction

CAD An Indian Perspective

Case Study 1 US CAD and the Financial Crisis

Case Study 2 Brazil : From Surplus to Deficit

BOP: Balance of Payments

1 Trade Balance

Current Account = Trade Balance + Factor Income + Cash Transfer

Trade Balance : Exports Imports Factor Income :Earnings on foreign investments payments made to foreign investors Cash Transfers BOP

1 Current Account

2 Factor Income

3 Cash Transfer

Capital Account

Current Account : An Overview

Nature of a Countrys foreign trade Trade Balance Current Account

Factor Income

Foreign Assets

Deficit

Surplus Foreign Assets

Positive Net Exports are generally accompanied by a Current Account Surplus However , in case of closed economy , the Factor Income may offset the Trade surplus and might result in Current Account Deficit

Current Account : How is it calculated

Current Account

Consists of Donations, Aids and Official Assistance

Goods

Services

Income

Current Transfers

Exports Imports

Provided Availed

Inflow Outflow

Inflow Outflow

LEGEND :

Credit

Debit :

The relation between CAD and Fiscal Deficit

Current Account

Private Savings

Investment

Fiscal Balance

Is CAD always BAD?

Current Account Deficit

Pitchford Thesis

Consenting Adults

Inter-temporal Trade

Excess of Investments

Low Savings

Excess of Imports

Transactions considered financially sound

Running a CAD today to achieve a CAS at a later point in time

Indicates highly productive and growing economy

Excessive Consumption Reckless Fiscal policy

Indicate Competitiven ess problems

The Classic Answer : It Depends !!!!

India : Current Scenario

Indias CAD, at 3.9% of GDP Q1 2012 is approaching 1991 levels

Source : (1) Euromonitor International

A persistent trade deficit has been the source of Indias CAD woes

Source : (1) Euromonitor International

Trade deficit has been persistently negative, leading to CAD in India

Reasons for lacklustre export growth

Exports
India has lost export competitiveness due to a fall in manufacturing activities
Traditional export items like textiles and readymade garments, and leather and other manufactured goods have been growing at decreasing rates. Regulations having reservations for small scale industries, reservations etc. Harsh labour laws Unfavourable indirect taxes

Imports
21% pa growth

16% pa growth

Poor infrastructure (road, logistics, storage, supply chain bottlenecks)

Delays in transportation (port congestion, road transport)

Rising fiscal deficit is also a contributor to CAD

Private Savings (S-I)

Public Savings (T-G)

Net Exports (X-M)

India has been running a persistent fiscal deficit leading to negative public savings, which hasnt been compensated by an equivalent increase in private savings (which has remained flat at around 30%) , leading to current account deficit A high current account deficit means that a country isnt able to sustain its day to day expenses from the revenue it earns

-2 Correlation Coefficient = 0.52 -4

-6 Budget balance (% GDP) Trade balance (% GDP)

-8

-10

-12 Source : (1)Euromonitor International

Gold and oil imports coupled with the depreciating Rupee is a major concern
22% rise in Gold and silver, cokes and briquettes and electronic goods imports from FY 2001- FY 2010
40000 35000 30000 25000 20000 15000 10000 5000 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 -3.0 -4.0 Gold Imports (US$ Mn) 1.0 Current Account Balance (% GDP) 0.0 -1.0 -2.0 2.0

Gold and silver combined were the 2nd most imported commodity in 2010-11. Whereas comparatively the import share of other key industrial raw materials such as Coal, Coke, Iron and Steel is much lower in the total import bill of the country. Global economic uncertainty has led to gold being considered as a safe haven asset
Source : (1) Euromonitor International

Unfavorable exchange rate movements with increasing oil prices raised imports

Share of crude oil imports increased from 23% in FY 1995 to 31% of the import bill in FY 2010
Petroleum/Crude imports (US$ Mn) Current Account Balance (% GDP) 160,000 % Change in currency (Rs/$) 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 15.0 10.0 5.0 0.0 -5.0 -10.0

-15.0
-20.0 -25.0 -30.0 -35.0

The middle East crisis and US tensions with Iran (Irans threats to shut down the Strait of Hormuz) were responsible for high oil prices. Speculation over the commodity market could also be a cause of oil price increase However, lower overall global demand, specially because of the Euro crisis, is expected to lead to easing of oil prices
Source : (1) Euromonitor International

Aggregate demand (C+I) exceeds Domestic Output (Y) - Compared to its Asian peers, India remains a low export, high import (consumption) economy
Indias growth is mainly consumption driven and not manufacturing driven (export driven). As a result, despite the global economic turmoil, Indias growth wont be affected. The downside to this is that this consumption is dependent on variables such as exchange rate. An appreciation of the Indian currency due to foreign capital inflows would boost imports, and hence consumption, but a depreciation of the rupee would adversely affect consumption.

Source : (1)Kotak Mahindra Research

How does Indias CAD sustain itself?

Deficits in Indias CAD are made up for by surpluses in its Capital Account

Over the last three years, Indias CAD has deteriorated steadily owing to the global financial crisis, Euro crisis and weak global economy. Capital flows may be unsustainable and volatile in the long run, as sudden outflows may destabilize the economy

Source : (1)Kotak Mahindra Research

Indias exchange rate fluctuates in tandem with portfolio flows

Excess appreciation of the currency due to capital inflows discourages exports and increases imports, leading to deindustrialization and loss of employment

Source : (1)Kotak Mahindra Research

IT services and foreign remittances help prop the current account deficit

India received foreign remittances of US$ 54 Bn in 2010, making it the largest receiver of remittances in the world

The IT industry has played a major role in propping up the current account, specially during the 2008 financial crisis. The industry has been bringing in foreign exchange through the export of its services and its employees across the world have contributed to the remittance pool. Remittances remained stable at US$ 46 bn in 2009, whereas capital account saw huge swings

Source : (1) Euromonitor International

Is Indias CAD sustainable for long term growth?

Economists and former RBI Governors opine that the sustainable level of CAD is around 2.5%
The current CAD levels are not too high for India to cut imports drastically and provide high levels of export subsidies. These levels, though high, can be taken care of by effective policy measures. A strong self-correcting mechanism is at work. The big CAD has caused the rupee to fall sharply, from Rs 45 to Rs 56 to the dollar. As a result, the rupee has weakened to a very competitive level, which by itself should trim the CAD.

Despite policy paralysis and a poor investment climate, India received large inflows of both FDI and foreign portfolio inflows in 2012. Despite bad publicity from the alleged mistreatment of Vodafone and Walmart, FDI inflows actually shot up 34.4% to $46.84 billion in 2011-12. FII inflows are typically far more volatile than FDI. However, despite the Eurozone crisis and recent slowdown in the US, FII inflows into India exceeded $10 billion in January-July 2012.

Growth-inducing policy measures would lead to increased confidence in the economy that would bring in more capital inflows. Also, with the INR deemed to have reached the true levels that reflect the state of Indias economy, further depreciation seems unlikely and with the advent of J-curve effect, Indias CAD would become more favourable over a period of time.

Our Recommendations

Recommendations to improve CAD

Build strong manufacturing base, boost exports
Currently India has surplus workers in agricultural sector. If manufacturing sector gets a boost, these surplus workers could get employment Diversification of current export basket in terms of location (reduce dependency on Eurozone) as well as products Indian exports need to move up value chain at global level Recent government policies like FDI in retail and aviation encourage capital flows and capital account surplus, which can cushion CAD . Local land restrictions, labour, political and environmental restrictions are in a state of flux, and these uncertainties make it more difficult for foreign investors to invest in India.

Encourage FDI/FII inflows

Tax sops for manufacturing specially small scale industries. Encourage foreign investment in roads, infrastructure, logistics and supply chain.

Increase in number of SEZs

SEZs have made exporting easier and hence export growth from SEZs has been phenomenal (121% y-o-y growth 2009-2010)

Recommendations to improve CAD

Improve productivity / Encourage private enterprise and innovation. All such measures will improve A number of projects are structural reforms productivity.labour laws, unfavourablestuck in bureaucratic mire environmental regulations, tax policies etc.

There should be reforms to improve governance and reduce wastage in government programmes

Replicate Brazil model

Export growth through growth in agricultural products - India has the largest arable land in the world and is one of the largest producers of agricultural commodities and grains. However, net exports have remained small and the variety hasnt changed over the years
. India could increase its agricultural exports through drastic measures like the Green Revolution of the 1970s.

Recommendations to improve CAD

Reduce gold demand

Reduction in demand of gold through education of investors of alternative sources of investment Increase domestic production of gold to reduce dependency on imports

Discover/develop alternate energy sources

Encourage through policies and investments in development of alternative sources of energy like Shale gas Following model of Gujarat of boosting investments in solar panels would go a long way in reducing Indias oil imports over a long period of time.

Use Monetary policy

Offset unfavourable exchange rates. E.g. use open market operations to increase/decrease liquidity and interest rates to regulate capital flows in/outside the country

Case Study 1 : US Current Account Deficit and 2008 Financial Crisis

2008 Financial Crisis : What went wrong

Net Savors to Net Debtors

High Oil Prices

Current Account Deficit

Oil exporting countries having huge income

Large Treasury Debt issued

US considered a safe haven

Invested in US

Mortgage backed seurities

Investors moved to riskier assets

As investments increased Yield decreased

United States of America : CAD and 2008 Financial Crisis

This line denotes Investment (as a percentage of GDP)
Current Account Balance(In $ billion)
Source : (1) World Bank Statistics (2) World Economic Outlook

United States of America : Housing Price Index(1)

Source : (1) http://www.frbsf.org/publications/economics/letter/2011/el2011-37.html

Case Study 2 : Brazil Current Account Surplus to Current Account Deficit

Brazil : The falling BRICK?

2004-2007 Current Account Surplus 2008 Sub-prime Crisis

Surplus turns to Deficit

Developing Economy Growing Demand

Low Exports*

High Import demand

Although the Surplus was low, but it is a good sign for a Developing country

Increasing Deficit

Heavy dependence on External funding Might lead to

Weak Currency

Debt Trap

High Inflation

* - Due to weak Global demand, the exports were falling

Brazil : Current Account Surplus to CAD

Source : (1) World Bank Statistics

Current Account Balance(In $ billion)

In the long run we are all dead - John Maynard Keynes ..so enjoy life while you still can