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Does high current account deficit bring down the value of currency? Or does the depreciation of currency raise the current account deficit? Even as India’s policy-makers remain busy finding out the impact of one on another the current account deficit, after remaining low for the last five years, has begun to rise in the current year.

Current account deficit rises

India’s current account deficit is feared to widen to about 2.8% of gross domestic product in the current fiscal – the highest in six years – says a report by Nomura, the Japanese financial services major. High oil prices, a depreciating rupee and outflow of foreign portfolio investment are all affecting India’s trade balance. The report further states, “Balance of Payment (BOP) funding to remain a challenge in 2018-19 as the basic BOP (current account plus net foreign direct investment) is negative and portfolio flows also remain negative.” The current account deficit (CAD), which is the difference between the inflow and outflow of foreign exchange, increased to $48.7 billion, or 1.9% of GDP in 2017-18. This was higher than $14.4 billion or 0.6% of GDP in 2016-17. Nomura’s forecast of higher CAD in 2018-19 is reflected in the trade deficit in the first quarter of 2018-19. India’s current account deficit was estimated at $15.8 billion in Q1 of 2018-19 as compared to $15.0 in Q1 of 2017-18. This was 2.4% of GDP. The widening of the CAD was primarily on account of a higher trade deficit at $45.7 billion as compared with $41.9 billion a year ago.

If at 2.4% of GDP, the CAD was lower compared to 2.5% of the same quarter of 2017-18, the up-trend is clearly visible when a long term trend is looked at. During the last seven quarters only once, in April-June 2017 quarter the CAD was higher than the Q1 of the current year.

Maybe at 2.4% or even at 2.8% of GDP, the CAD figure would not pose an immediate concern for the North Block, but if one remembers the story of 2012-2013 when it spiraled to over 5% of GDP, the rising trend of CAD would need a serious look.

Gold import jumps after falling for five months

How to control current account deficit by raising exports or by cutting imports or both? If the government cannot curb imports to any significant extent since the larger part of the import bill is accounted for by oil, it can take measures to cut imports of less important items, say, gold. After falling for five months between January and May 2018, the import of gold has seen a sharp rise. Import has gone up by 43.4% in three months, between July and August.

Lower export growth raises trade deficit

Amidst concern for increasing exports, India’s merchandise exports declined last September. Exports declined by 2.2% on a yearly basis. Imports, however, went up by 10.5% in the same month resulting in a trade deficit of $13.98 billion. The cumulative exports during April-October 2018-19 were estimated at $191.01 billion (RS. 13,23,940.28 crore) as against $168.64 billion (RS. 10,87,270 crore) in the same period last year – up by 13.3% in dollar terms and 21.8% in rupee terms. The cumulative imports during the same period was estimated at $302.47 billion (RS. 20,97,058 crore) against $259.92 billion (RS. 16,75,887.95 crore) in the same period last year – up 16.4% growth  in dollar terms and 5.1% in rupee terms.

Much of this distortion in the export-import equation was due to rise in international crude prices. This is reflected in the sharp rise in the oil import bill. The cumulative oil import bill went up by 50.1% to reach $83.94 billion during April-October 2018 from $55.78 billion in the same period last year. The effect of the fall in rupee value against dollar was clearly evident in the sharper rise in import bill in rupee terms – up by 62% during the same period.

One hopes that the recent downtrend in crude prices would continue and would correspondingly bring down India’s import bill on oil. In fact, a study by SBI Research suggests that following decline in oil prices CAD is expected to settle down at 2.6% of GDP in the current year against the earlier estimate of 2.8%. However, even at 2.6% it will be higher than 1.9% recorded last year.

Economists feel that the rising CAD is a big risk to the Indian economy and fear that further deterioration of CAD could result in policy paralysis. The outlook for advanced economies remains uncertain, and even if there may be no event shocks, there could well be process shocks which could result in capital outflows from the emerging developing economies.

What must bother the Finance Minister even more is that even as the large CAD is a risk by itself, its financing exposes the economy to the risk of sudden stop and reversal of capital flows. Should global liquidity rapidly tighten, India could potentially face a problem of the reversal of capital flows distorting macro-economic stability. A large CAD, appreciably above the sustainable level for a long time will put pressure on servicing of external liabilities as well.

Trade war and India

Already, the continuing trade war between the US and China is posing a big question across the world. The trade war will not only affect China but also the traditional allies of the US. And if the prescription to check further fall in India’s CAD is to increase export, it has to ship more merchandise to the US. The US has traditionally been India’s biggest trade partner. More importantly, India has a positive balance of trade against the US year after year.

The share of the US in India’s total merchandise exports increased steadily over the years from 11.4% in 2011-12 to 15.8% in 2017-18. The share of the US in India’s total imports has increased from 4.8% to 5.7% during the same period. The relatively high growth in exports has resulted in a sharp rise in trade surplus. India’s merchandise trade surplus against the US has increased more than two and a half times during this period. Given this background, it is important for India to have smooth trade relations with the US.

An analysis by the industry chamber revealed that India should focus on the US market for items in the categories of machinery, electrical equipment, vehicles and transport parts, chemicals, plastics and rubber products. Interestingly, some of them are already among the top export items to the US.

On the flipside, expanding agricultural exports such as soybeans and cotton to China by exploiting opportunities from a global trade war will help cut the deficit too. Soybeans are at the heart of the trade war between the US and China and cotton isn’t far behind. It puts India in a position to step up and fill the gap left by the US.

China is already the top market for India’s overall export growth in recent months. Between April and August, India’s exports to China grew an average 52.9%. A diversification of products may help India to explore a greater export market in China and reduce trade deficit against it. In fact, nearly half of India’s trade deficit is accounted for by China.

Coming back to the question whether high CAD brings down currency value or, depreciation of currency raises the current account deficit, the answer would be largely affirmative. Depreciation of currency increases the cost of imports and since India’s total imports are always more than exports, it outweighs the price advantages accrued to exports.