Everything you need to know about current account deficit
A current account deficit occurs when the value of a country’s imports exceeds that of its exports. The current account is an indicator of the economic health of a country. But a layperson’s concept may be fuzzy. What is a current account deficit? And what are its impacts? To give you a clearer picture, here is a quick overview.
Current account deficit: What it means
All countries import and export goods and services. Income also moves from one country to others. This may be through salaries, interest, and even dividends from investment. Transfers like foreign aid, grants, and pensions are also part of the current account.
When does a country have a current account deficit? It is when the import value of its goods, services, and capital is higher than their export value.
This is also called a trade deficit because goods and services form the major chunk of the current account. Income and transfers represent only a small part of the current account balance.
How is current account deficit calculated?
There is a standard current account deficit formula for performing the calculation:
CAB = X – M (+ NY + NCT)
CAB: Current account balance
X: Value of exports of goods and services
M: Value of imports of goods and services
NY: Net income abroad
NCT: Net current transfers
When the current account balance is positive, there is a surplus. When it is negative, there is a deficit.
Here is another way of looking at it.
CAB = National Savings – National Investments
A deficit occurs when the total savings of a country are lower than its total investments.
Problems of a current account deficit
A current account deficit can be useful in the short term. It sets the stage to receive funds from abroad and ensure economic growth. But a deficit that persists over a long period is a problem. Further problems arise if the deficit forms a large part of the gross domestic product (GDP). Here are some of the negative impacts.
Investors stay away: Normally, investors from other countries pump in funds with an eye on potential returns. A country with a persistent current account deficit may not grow sufficiently. This may lead to low returns on investment. As a result, foreign investments could dry up.
Foreign control of domestic assets: A country with a current account deficit may depend extensively on foreign capital. Domestic players would have to turn to foreign multinationals for financing. In turn, foreign players could influence or even dictate policy decisions for domestic operations.
Uncompetitive domestic sector: A current account deficit could signal over-reliance on consumer spending. Goods and services produced within the country may be uncompetitive at the global level. Consequently, the value of exports would reduce further.
India’s current account deficit in 2016
Of late, India has been improving its current account deficit. In fact, in the quarter April–June 2016, India generated a deficit of 0.1% of the GDP. This amounted to $277 million. There had even been some expectation that the country would post its first-ever surplus.
Yet, even a year ago, for the same quarter, the deficit had been 1.2% of GDP. In monetary terms, it amounted to a deficit of $6.1 billion.
India has been one of the fastest-growing countries in the world. But it needs to increase the growth of imports to fuel further development. For example, a growth rate of at least 8% is necessary to ensure full employment within the country.