[op-ed snap] Signs of stability on external front

Note4Students: Op-ed discusses present situation of India’s CAD, factors that affect it and might affect in near future and other related aspects. Important.

Read B2B for knowing about highlighted terms.

From UPSC perspective, following things are important:

Prelims level: Current Account Deficit (CAD), Gross Domestic Product(GDP), hot money, exchange rate, Foreign
direct investments (FDI), trade deficit, fiscal
deficit, balance of payments

Mains level:Risks to India’s CAD and BoP by various
national and international factors, current trends and other related issues.

News: Context:

• Over the past few years, one of the prominent features of India’s improving macroeconomic fundamentals has been the reduction in its Current Account Deficit (CAD)
• CAD has declined successively, reaching 0.7% of GDP in fiscal 2017
• It had surged to 4.8% of Gross Domestic Product (GDP) following the taper tantrum of 2013 Positive Developments in external front in last few years
• CAD’s financing has also become more robustPrior to fiscal 2014, financing depended a lot on foreign portfolio inflows
• A chunk of that is “hot money” that exits quickly, leading to volatility in the exchange rate
• Foreign direct investments (FDI), which are way more durable and stable, have surpassed foreign portfolio inflows in the past two years
• Since fiscal 2015, FDI inflows alone have been sufficient to finance India’s CAD

Benefits of FDI:
• Increased employment opportunities Greater technological know-how Risks that India is facing on external front:
• Rising commodity prices: These increase India’s trade deficit because we import way more than we export
• Rising protectionism: Even as global demand improves, there are increased instances of rising protectionism in advanced economies
• Increasing manifestation of this trend will impair India’s external position
• US and Europe constitute the biggest chunks of India’s merchandise exports
• Immigration restrictions negatively affect the earnings of Indian workers abroad, which would reduce inward remittances
• As much as 80% of the remittances to India are personal transfers, and 60% by workers

Fiscal health of the Centre and the states:
• There is a trend reversalThe Centre’s fiscal deficit has
fallen from 5.8% of GDP in fiscal 2012 to 3.5% in 2017
• And that of states has risenThe situation could worsen
further for states, leading to a higher combined deficit

Twin Deficits Hypothesis: The Effect of Fiscal Consolidation on the Current Account

• Theoretically: A standard implication of many theoretical models is that a fiscal contraction leads to a depreciation of the real exchange rate and an accompanying fall in the current account deficit
• Practically: Empirical research suggests that such a rise in consolidated fiscal deficit may not automatically lead to expansion of CAD

• India’s balance of payments account is expected to remain healthy over the near term with CAD at moderate levels and adequately financed

Back2Basics: Read about fiscal deficits here
(click2read) Read about BoP and CAD here
(click2read) Know about FDI here (click-
2read) Hot Money Hot money is currency
that moves regularly, and quickly, between
financial markets so investors ensure they
are getting the highest short-term interest
rates available.

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