A comprehensive Study on India's Current Account Deficit (CAD) and the need to reduce it

Abstract

According to the Financial Stability Report, June 2013, Dr. D. Subaarao has highlighted the risk to macroeconomic stability from the rising current account deficit (CAD). According to him, “Cross border volatile capital flows have made India vulnerable to sudden stops and reversals, as evidenced recently, following the slightest hint of exit from quantitative easing (QE) by the Federal Reserve. Both the Government and the Reserve Bank have taken measures to dampen the import of gold in order to restrain the CAD to a more sustainable level. In the short-term, our efforts have been directed at financing the CAD as that will give space and time to put in place structural reforms that will address the more deep-seated problems confronting the economy. While stress tests reveal that the financial system is resilient to shocks currently, deteriorating macroeconomic stability can eventually erode financial stability.” The present CCS study is a comprehensive study on India’s Current Account Deficit (CAD) starting from 1980-81 till date. The project would entail the causes, cures and the need to reduce this large deficit. The study would analyze the trend India’s current account deficit has seen over all these years. It would also be compared with the deficit of other economies. The Balance of Payments crisis of India in1991 has led to tectonic changes in the Indian Economy. The High level Committee on Balance of Payments has laid the foundation for Flexible Exchange rate regime and convertibility on Current account. The committee also reported that a sustainable level of CAD is 1.6% of GDP. Later with an objective of liberalising the capital account, a committee on FCAC was assembled under the chairmanship of S.S Tarapore in 1996 and in 2006. Though some of the recommendations were not implemented, these committees brought the economy closer to a full convertibility on capital accounts. According to the 1997 committee, the sustainable level of CAD was pegged at 2.0% of GDP which was changed to 3.0% of GDP by the 2007 Committee. A study of international literature reveals that there is still a lot of debate over the causal factors of CAD and many other aspects of CAD. The accepted sustainable levels of CAD lie between 1.6 and 3.8 internationally. In our analysis of CAD of India, we have tried to isolate the factors leading to the high current account deficit. Based on available evidence we concluded that Exports have been increasing at a reasonable pace and because of inherit bottlenecks in the system, it is not able to push beyond a certain limit with the current structural environment. Next we have analysed the trends in imports, our analysis has showed that the rapid growth of imports (annual growth rate of 22.3% since 2007-08) is being fuelled by the rapid growth in imports of petroleum crude & products and Gold which account for nearly 33.5% of the total imports.