From UPSC perspective, the following things are important :
Prelims level : Current Account, CAD
Mains level : Read the attached story
The SBI has estimated a lower current account deficit at 3% for this fiscal as against the minimum consensus of 3.5%, citing rising software exports, remittances and a likely $5-billion jump in forex reserves via swap deals.
What is Current Account Deficit (CAD)?
- A current account is a key component of balance of payments, which is the account of transactions or exchanges made between entities in a country and the rest of the world.
- This includes a nation’s net trade in products and services, its net earnings on cross border investments including interest and dividends, and its net transfer payments such as remittances and foreign aid.
- A CAD arises when the value of goods and services imported exceeds the value of exports, while the trade balance refers to the net balance of export and import of goods or merchandise trade.
Components of Current Account
Current Account Deficit (CAD) = Trade Deficit + Net Income + Net Transfers
(1) Trade Deficit
- Trade Deficit = Imports – Exports
- A Country is said to have a trade deficit when it imports more goods and services than it exports.
- Trade deficit is an economic measure of a negative balance of trade in which a country’s imports exceeds its exports.
- A trade deficit represents an outflow of domestic currency to foreign markets.
(2) Net Income
- Net Income = Income Earned by MNCs from their investments in India.
- When foreign investment income exceeds the savings of the country’s residents, then the country has net income deficit.
- This foreign investment can help a country’s economy grow. But if foreign investors worry they won’t get a return in a reasonable amount of time, they will cut off funding.
- Net income is measured by the following things:
- Payments made to foreigners in the form of dividends of domestic stocks.
- Interest payments on bonds.
- Wages paid to foreigners working in the country.
(3) Net Transfers
- In Net Transfers, foreign residents send back money to their home countries. It also includes government grants to foreigners.
- It Includes Remittances, Gifts, Donation etc
How Current Account Transaction does takes place?
- While understanding the Current Account Deficit in detail, it is important to understand what the current account transactions are.
- Current account transactions are transactions that require foreign currency.
- Following transactions with from which component these transactions belong to :
- Component 1 : Payments connection with Foreign trade – Import & Export
- Component 2 : Interest on loans to other countries and Net income from investments in other countries
- Component 3 : Remittances for living expenses of parents, spouse and children residing abroad, and Expenses in connection with Foreign travel, Education and Medical care of parents, spouse and children
What has the SBI said?
- The biggest impact on CAD is oil imports, which form as much as 30% of the country’s import bills.
- Every $10 increase in crude prices impacts the CAD to the tune of 40 basis points while the same on fuel inflation is 50 bps and also results in 23 bps decline in growth.
- Strong remittances and software exports had lowered CAD by 60 basis points (bps) in the June quarter.
- Forex reserves, which have declined from $642 billion in September 2021 to about $531 billion last week, are expected to rise by $5 billion as swap transactions reverse.