Current Account Deficit of India

Effects of Various Factors on Current

Account Deficit of India

Dipankar Sharma
MBA Section B

Jeevandeep Singh
MBS Section B

Current Account Deficit of India

Objectives of Study
The study is aimed to fullfill the following objectives:

To
To
To
To

study the Current Account Deficit of India

study various the Trade Balance of India
Determine Various Factors effecting the CAD of India
propose paulsible solutions to reduce the effect of various factors

Introduction
Global economies are always in transition. Development and growth are moving targets for
all economies of the world. Therefore, the related issues often give rise to new research
areas.Before one could pin point the research areas , some one question need to be
answered ,What are some of the issues that worry a government, particularly the finance
ministers, most? One could say that governance in the modern times is a difficult task and
there is always an inexhaustible list of problems to resolve. Be that as it may. Yet, one can
enumerate the macro problems that the finance ministers have to grapple with all the time.
These are: economic or GDP growth, reduction in unemployment, reduction in inflation and
reduction of external imbalance.
Though all the four are interconnected, yet depending on the seriousness, one or the other of
these issues becomes a cause of concern at different times. There are no universal solutions.
Each country may have to respond differently taking into account the prevailing
circumstances. For example, the external imbalance manifests in terms of current account
deficit (CAD) and may require several steps to keep it at a reasonably low level.
In a country like India which imports majority of its essential commodities like crude oil ,
precious metals , energy minerals etc , maintaining a Balance of the Current Account is of
paramount importance to have a progressive and a stable economy. The current account is
an important indicator about an economy's health. It is defined as the sum of the balance of
trade (goods and services exports less imports), net income from abroad and net current
transfers.'Current Account Deficit' is a measurement of a country's trade in which the value
of goods and services it imports exceeds the value of goods and services it exports.
Balance of Payments (BoP) for a country is a statistical statement that summarizes economic
transactions between its residents and non-residents during a specific time period. In 2010-11,
Reserve Bank of India shifted to the reporting pattern of International Monetary Funds
Balance of Payment and International Investment Position Manual 6 (BMP 6), which
classifies BoP transactions as (i) current account (ii) capital account and (iii) finance account
transactions. Current Account includes transactions under the heads goods (including
general merchandise, non-official gold imports etc.), services, primary income (including
compensation of employees, investment income etc.) and secondary income (including
personal transfers and remittances etc.). Hence it measures the exports and imports of

Current Account Deficit of India

commodities and services, the movement of investment income from one home country to the
rest of the world and vice-versa. It measures unilateral transfers between the agents of the
domestic country and the rest of the world. Indias fiscal imbalance since 1980 has been
widening when during that period, India started to have balance of payments problems. As a
result of the Gulf War, Indias oil import bill grew, exports went down, credit dried
completely, and investors took their cash out. Large fiscal deficits, consequently, had a
snowballing effect on the trade deficit culminating in an external payments crisis. High
imports and plummeting exports widened the Current Account Deficit (CAD) and led to
serious repercussions. Current Account Deficit (CAD) has been a major concern for the
Indian Economy for the past 5 years. In Q2-2013, CAD increased and reached 4.4% of GDP.
Current Account (CA) of is the record of net of all exports, imports, services,
dividend/interest and transfer payments between a country and the world that have occurred
during a year Current Account can be divided into 3 major components:

Exports
Imports
Invisibles

CA can also be interpreted as the difference between National Savings and Investment. Given
this nature of interpretation, CAD is seen as a necessary feature of a developing economy,
such as India, as there is higher need for investments compared to mature economies. At the
same time, CAD is known for systematically undermining the macroeconomic stability, as
experienced by India during early 1990s.

Current account balance (% of GDP)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Current account balance (% of GDP)

Current Account Deficit of India

The sizes of current account and fiscal balances are important indicators of the
macroeconomic stability and well-being of a country. As economy grows, its demand for
foreign goods and services grows simultaneously and the world trade benefits as a whole.
Problem that arises is not caused by increasing imports but by a mismatch between exports
and imports growth. Without a stable balance between exports and imports, current account
imbalance will tend to expand. Cointegration between exports and imports implies that
current account deficit (CAD) is only a temporary phenomenon and current account
converges toward equilibrium over the long-run. It, in turn, means that the country is not in
violation of its International Budget Constraint (IBC), because its macroeconomic policies
have been effective in bringing exports and imports into a long-run equilibrium.

History
Indias current account position has historically mainly been one of a deficit which is
accompanied by a substantial fiscal deficit (FD), as depicted in Figure below. Indias First
and Second Five-Year Plans (1951-61) focused on rapid import-substitution industrialization
with the main aim of self-sufficiency. The objective also manifested itself in the country
foreign trade policy where imports were strictly quantitative import restrictions, which were
supplemented by a composite tariff structure with high and differentiated rates across
industries

Current Account Deficit of India

The extensive protection reduced competition drastically, engendered inefficiency in

domestic industries and generated monopoly rent, which resulted in a distinct anti-export
bias. With the export performance remained poor, Indias trade deficit widened and current
account deficit increased to 2.4% of Gross Domestic Product (GDP) as the surplus of
invisible account also narrowed in 1966-67. This situation was further aggravated by a high
fiscal deficit of 9.7% of GDP for the same period, as seen in figure above.
The pressure on external position led to a more conductive export environment, with the
introduction of a number of exports promotional schemes, including the devaluation of Indian
rupee in June 1966-the rupee devaluated from Rs 4.7 to Rs 7.5 per dollar. The devolution was
accompanied by some liberalisation of import licensing and cuts in import tariffs, and
introduction of export subsidies for approximately a year. Improved export performance due
to expansion of the worlds total trade and export incentives led to an improvement in Indias
current account position during the late 1960s and early 1970s. While this moderation was
temporarily reversed in the aftermath of oil prices shock of 1973, a tightening of import
control, generous external assistant and fiscal conservatism quickly brought import down.

In the late 1970s, a combination of high domestic inflation, a large fiscal deficit (i.e., 7.1 % of
GDP in 1977), second worlds oil price hike of 1979 and a pegged exchange rate generated:
(a) low exports, (b) more imports, (c)a wider current account deficit (i.e., 1.1% of GDP in
1977), and (d) near-exhaustion of reserves. As reserves fell critically low, India undertook an
International Monetary Fund (IMF) program in 1981. However, unlike first half of the 1970s,
no significant current account adjustment followed. With a large macroeconomic imbalance
developing in the second half of 1980s, particularly a large fiscal deficit (e.g., 9.1 % of GDP
in 1987), growing public debt, high external debt, and their expansionary influences on
money supply and high rate of inflation, the current account deficit burgeoned-picked up to
3% of GDP in 1990-91. While the trade deficit remained in 2-2.5% of GDP range, the surplus
on invisible account narrowed and moved into a small deficit during the same period.
Indias travails on the Balance of Payments front started from the Second Five-Year Plan
(1956), and continued till the crisis of 1991. The 1991 Balance of Payments crisis forced
India to open her long shut doors to foreign investments. This was done in a gradual manner
by removing various restrictions, which caused India to be under a License Raj. During the
License Raj, eighty government agencies had to be satisfied for private companies to produce
goods and, the government would regulate production. After the reforms the economy saw a
turnaround, from the ease of doing or starting a business to attracting capital flows from
abroad.
The opening up the economy led to the inflow of capital from the world. The inflow of
foreign capital was good for the economy. India was more connected to the outer world.
However, India also had to bear with the uncertainty and speculation surrounding the global
financial markets.
The free flow of capital can be a blessing and a curse. Heavy dependence on the inflow of
capital in the Capital Account to balance the Balance Of Payments account is dangerous.
India is a developing economy and heavily dependent on oil and petroleum products, not just
for transport, but for many other industries as well. India is not rich in oil reserves and
depends on oil imports for her needs.

Current Account Deficit of India

The erosion of international confidence in the Indian economy not only made borrowings in
international markets difficult but also led to an outflow of deposits of non-resident Indians
with Indian banks. Investment income payments also raised as the structure of external
financing shifted away from concessional finance toward higher-cost debt. This situation was
further aggravated by indiscriminate fiscal profligacy. It resulted in a sudden drying up of
India's foreign reserves (US$ 3962 million or 1.28 per cent of GDP in 1989-90). As foreign
exchange reserves close to exhaust, India was brought to a brink of default with respect to
external payments liability in January 1991. This was averted by resorting to borrowings
from the IMF under the stand-by arrangements (in January and July 1991), mortgaging gold
to the Bank of England and adoption of IMF programme. On 4 July 1991, the Government of
India undertook the major task of fundamentally altering its development paradigm by
announcing a massive dose of external liberalization and other major policies aimed at
reducing the fiscal deficit and the current account deficit. The trade liberalization measures
include: (a) devaluation of the currency, (b) steady decline in the ceiling on custom duties
peak tariff rates brought down to maximum 50 per cent from up to 355 per cent, (c)
drastically prune in the complex import licensing system, (d) removal of non-tariff barriers
(NTBs) like quantitative and other restrictions from all tradable except consumer goods, (e)
decontrol of foreign exchange, and (f) announcement of sector/market-specific export
promotion schemes. For reduction in fiscal deficit, central bank credit for the government
(which is the major source of financing the central government fiscal deficit) was reduced.
Recently, Indias net current account balance has been turned from a surplus of $14.08 billion
in 2003-04 to a deficit of $2.47 billion in 2004-05 which further widened to $38.44 billion or
2.9 per cent of GDP in 2009-10. The fiscal deficit has also been reached to its peak of 9.5 per
cent of GDP during the same period.
In the year 2011-12 and 2012-13, current account balance for India reached deficit levels of
4.6 % (US$ 78 billion) and 4.8 % of GDP (US$ 87 billion), mainly on account of a more
specific trade deficit phenomenon arising from merchandise goods and gold trade deficits.
Compared to Current Account Deficit (CAD) figures of 4.6 % and 4.8 % of GDP, Indias
trade deficits stood at 10.2 % and 10.8 % of GDP for the years 2011-12 and 2012-13. Also,
usually invisible surpluses comprising service exports and income transfers like
remittances from abroad have played a crucial role in evening out large trade deficits in India.
The remaining CAD in turn have been getting financed by net capital inflows belonging to
the financial account, although concerns about volatile nature of these inflows due to
predominant share of portfolio investment have been expressed time and again. However, in
recent times, while invisibles have remained stagnant, capital inflows have reduced
significantly in the post financial crisis scenario.

Current Account Deficit of India

CURRENT SITUATION
CAD has gone up sharply in the last two years on the back of higher oil and gold imports.
Export growth slowdown has also hit the CAD. There is a huge difference in our imports and
exports , which leads to our current account being in negetive . Balance of Trade is very
Important to stablise the Current Account as well as the economy of a nation. But in a country
like India a vast disparity exists in Total Trade of Imports and Total Trades of Exports
Indicator
Name
Exports of
goods and
services
(% of
GDP)
Imports of
goods and
services
(% of
GDP)
Trade (%
of GDP)

200
200 200 200 200 201 201 201 2013 201
5
6
7
8
9
0
1
2
4
19.2
21.
20.
23.
20. 21.9
24. 24.4
25.1
23.
8
07
43
60
05
7
27
3
6
59

22.0
3

24.
23

24.
45

28.
67

25.
43

26.3
4

30.
75

31.1
2

28.1
2

25.
96

41.3
1

45.
30

44.
88

52.
27

45.
48

48.3
1

55.
02

55.5
5

53.2
8

49.
56

Trade Balance
Exports of goods and services (% of GDP)

Imports of goods and services (% of GDP)

Trade (% of GDP)

Current Account Deficit of India

The graph shows us the Line Chart Diagram of Total Imports of goods and services and Total
Export of Goods and Services as percentage of GDP.
Indicator Name

2011 2012 2013

Exports of goods and services (current US$

Billion)
Imports of goods and services (current US$
Billion)
External balance on goods and services
(current US$ Billion)

2014

445

447

468

487

564

570

523

536

-118

-122

-55

-49

Trade Balance

Exports of goods and

services (current US$
Billion)
Imports of goods and
services (current US$
Billion)
External balance on goods
and services (current
US$Billion)

The graph shows a Bar Chart of Exports and Imports and External balances of India
Oil imports make up a large portion of the total imports and rupee depreciate pushes up the
oil bill causing problems to the CAD. In addition to oil, gold also has joined in to cause
trouble to the CAD. The metal is a favourite with Indians and is seen as a very attractive
investment. Gold imports are increasing and this is adding to the CAD.

Current Account Deficit of India

The exports sector is not growing at a rate to cover the import bill. The Import bill has
increased at a rate of 31% during 2011-15, while exports only grew at 23% for the same
period. Oil imports have increased at a rate of 46% and gold 38%. This rise in oil and gold
imports is alarming and can negatively impact the CAD if not checked. A high and
uncontrollable CAD may scare foreign investors which in turn would weaken the rupee,
which then would cause a further strain on the CAD.
Given these basic trends in Indias CAD and its financing pattern, detailed analysis of present
CAD reveals oil, gold, coal and iron ore as some of the key contributors for the present
situation. With a stockpile of 25000 tonnes and accounting for around a quarter of the world
demand, gold imports in India increased from US$ 33 billion (in 2009-10) to US$ 57 billion
(2011-12) and US$ 53 billion (2012-13). Share of gold in imports has also increased
considerably from 7.6 % (2005-06) to 12.6 % (2011-12). Main reason for this phenomenon is
said to have been the increase in global prices of gold in the post financial crisis scenario, as
the worlds savers looked for safe havens to park their savings. Since 2005, gold price has
doubled in terms of US$ and tripled in terms of Rupee. Surpassing returns on other
investment, between 2007 and 2012, gold gave annual average returns of 23.7 % as compared
to 7.3 % by Nifty (National Stock Exchange in India) and 8.2 % by Savings Deposits. In
addition, it acts as a good hedge against inflation, which reduces real return on investments
(inflation in India stood at 9.6 % and 8.9 % for the years 2010-11 and 2011-12 respectively).
Hence, the recent spurt in gold demand and import by India is less about its historical affinity
for consumption as jewellery and more about investment dynamics. Gold Loan schemes by
Banking and Non-Banking Financial Companies (NBFCs) have further encouraged this
demand. While in the year 2008, total gold loans stood at Rs 20,000 crore, the same stood at
Rs. 1,50,000 crore in the year 2012. In addition to these, other benefits associated with gold
like liquidity, safe source for parking black money, saving instrument for rural areas lacking
banking facilities etc. also continued to exert pressure on gold demand.
However, though gold imports have been one of the main reasons for the present CAD, nongold trade deficits also deteriorated sharply from US$ 96 billion (2010-11) to US$ 131 billion
(2011-12) and US$ 144 billion (2012-13). Rising oil and coal import bills and reduced iron
ore export earnings have been some of the main components for this trend. Oil bill continues
to be one of main components on Indian import bill in light of the inelastic and growing
energy demand and rising global crude prices due to exogenous factors like Middle East
political economy and recent Arab Spring episodes. Studies have estimated that each US$ 10
per barrel change in crude price impacts current account balance in India by around US$ 8
billion.
For Coal, though possessing worlds second largest coal reserves, Indias import of the same
has increased steadily from 20 million tonnes (mt) in 2001 to 74 mt in 2009 and 130 mt in
2012, resulting in an import bill of around US$ 18 billion. With around 60 % to 70 % of the
countrys electricity being generated from coal, imports are expected to increase further in
future due to domestic production constraints.
As regards Iron Ore, while India exported 117 mt of iron ore in 2009-10, the figures saw a
steep decline to 18 mt in 2012-13. With India expected to be a net importer of iron ore in
2013-14, this will mark a quick shift in Indias position from being the third largest exporter
of iron ore to a net importer over a very short period of time. Main reasons for this trend are
said to have been a cap in production in Karnataka, ban in Goa and strict enforcement of
environmental regulations in Odisha due to Supreme Court rulings and state interventions.

Current Account Deficit of India

10

Given these diverse forces at play, an effective policy intervention to address present CAD
has also to be necessarily multi-pronged. Also, with little room available for managing oil
imports in the short run, present CAD management has to be through non-oil components
only. While since January 2012, government has gradually raised import duty on gold from 2
% to 10 %, the same has been protested by gems and Jewellery industry saying that it would
adversely impact the Rs. 2,75,000 crore industry employing around 60 million people.
Increased duty is also believed to have resulted in increased smuggling of gold.

Need For Study

Given the complexities involved and the time it might take to set the non-oil current account
deficit to tune, government is exploring options to finance the same via long term stable
finance account flows. Some of the options that have been recently suggested and tried
include liberalization of Foreign Direct Investment policy, allowing PSUs to raise money
abroad, continued attracting of sovereign wealth and pension funds to India, raising money
from NRIs, and loosening of restrictions for borrowing by Indian companies abroad etc.
Today, the external sector transactions amount to around 108 % of GDP, as compared to
around 30 % of GDP for the year 1990-91. These figures point towards a more compelling
need to diversify Indian exports, both destination wise and commodity wise. While it is
always prudent to take lessons from history, every situation or challenge comes with its own
peculiarities. Recent CAD trends in India have clearly shown that increased integration with
the global economy brings with it both opportunities and challenges, and it is here that the
role of government becomes most crucial to play a balancing act between these two
tendencies. It is, therefore, instructive to what factors affect the current account deficit.

Current Account Deficit of India

11

Causes of the Current Account Deficit

Indias Import Composition
One can correlate the composition of Indias import basket and the prices of the significant
commodities in it to the downward trend in the Current Account graph.

A substantial portion of our import bill is because of energy related and precious metal
commodities. In the current circumstances one would expect the mounting prices (due to
global commodity pricing and rupee depreciation) to reduce imports. However the demand
for energy related commodities is price inelastic (change in price does not affect the quantity
demanded) in the cases of necessary fuel inputs. Especially under the monetary policy
employed by the Government, coal, oil, and natural gas are heavily subsidized in order to
maintain certain prices. Therefore, the increase in prices is not reflected to the actual
consumers (which would drive down demand).They are reflected in Government
overspending, resulting in a fiscal deficit (Government spending more money than it is
making).

Current Account Deficit of India

12

Gold Imports
The global demand for gold primarily comes from three sources: jewellery, industry
(including medical applications) and investments (that are unproductive in nature). Based on
data from last few years, the World Gold Council released the following breakdown in India`s
demand for gold as per each of the sources.

Uses of GOLD in India

Industrial; 8%

Jewellery; 42%

Investment; 50%

So if people give up on Jewellery, Gold will be among the least useful metals.
India imports three things mainly Crude Oil, Cooking Oil and Gold. The first two are
essentials. Gold is considered to be Non-essential. So our Government wants to reduce the
import of Gold. Coming to CAD(Current Account Deficit), A measurement of a countrys
trade in which the value of goods and services it imports exceeds the value of goods and
services it exports. In short Current Account is the difference between a countrys Total
Exports to Total Imports. If we have CAD, we need to use our Forex reserves to settle and in
the process, we deplete the Forex reserves. If it continues, in the long run we might not have
money to get imports. Now let me give you some statistics. In 2001, the total world
production of Gold was 3764 tonnes and India imported 462 tonnes, which turns out to be
12.27% of the total production. In 2012, the total production was 4130 tonnes. India imported
1079 tonnes which turns to be 26.12%. India's production is least considerable while it has
consumed one-fourth of the total gold production. From 2007 to 2012, CAD has increased
from 1.3 to 4.2% of GDP. Net Gold imports has increased from 1.1 to 2.7% of GDP. Net Gold
to Current Account Balance has hovered around 70%. Gold export as percentage of Gold
Import has decreased from 41% in 2008-09 to 29% in 2011-12 and a record high of 6.7 per
cent of GDP in 2013. Gold has remained as one of the chief contributors to CAD. In brief, if
we stop importing gold, our CAD would become 1.2% of GDP. In 2011 12 India imported
55 billion USD worth of gold. It resulted in 50% of the current account deficit for the nation
in the same year.High gold imports is one of main reasons behind high Current Account

Current Account Deficit of India

13

Deficit (CAD), which touched a record high of 6.7 per cent of GDP in December quarter of
last fiscal. The CAD is likely to be in the range of 5 per cent for the 2012-13 fiscal. As per
experts a CAD of 2.5 per cent is sustainable. The high CAD in turn affects rupee value. The
rupee hit life-time low of 59.05 against the US dollar. The country spent $56.8 billion of its
precious foreign exchange reserves on gold imports in 2012. Hence spending this huge
amount on a non-essential metal effects the economy of the country and Gold accounts for
one half of India's Current Account Deficit. This is because of the desire of Indians to hold
their capital in the form of gold as an "Unhealthy Addiction". So our Government strongly
wants to reduce the import of Gold.

India is largest importer of gold after china and In first quarter of 2015 it also
surpassed china as biggest consumer of gold
Traditional Indians looks gold as preserver of wealth and means of savings as opposed
to banking system
Since Indian Economist looks gold imports as unproductive to indian economy as
against OIL which adds value to our economy through increased industrial
production
Also government had also been effective in reducing CAD during 2013 NOV-DEC by
imposing several import duties and quotas on gold imports

The global demand for gold primarily comes from three sources: jewellery, industry
(including medical applications) and investments (that are unproductive in nature). Based on
data from last few years, the World Gold Council released the following breakdown in global
demand for gold as per each of the sources.

The Essential Commodities Act of 1955 does not list gold as an essential commodity. Based
on this Act, one can infer that essential commodities are goods required to sustain the
economy of a country either as basic inputs to the economic engine or as inputs necessary for
increasing domestic productivity in various sectors. Unproductive investments are
characterized by not producing any goods or services with any exchange value. By these
definitions, only the industrial demand for gold can be considered productive as an
investment. High investments in the bullion market can be classified as unproductive and
non-essential as gold commodity trading doesnt directly produce any goods or services that
will contribute to the robustness of an economy. Hence, one can conclude that 88 % of the
global demand for gold is unproductive.

According to a World Gold Council paper published in 2010, 23 % of the global demand for
gold jewellery comes from India.
Financing high imports of gold is not prudent as it encourages the negative trend of hoarding
that is prevalent in Indian communities. Excessive gold accumulation drains the health of an
economy by allowing savings to breed in vaults when the same savings could be invested in
the financial system. The overwhelming demand for gold for unproductive purposes in India,
(which contributes significantly to the current account deficit as indicated in the table below)
is very a serious problem. Hence, there is an immediate need to drastically cut down on
Indias imports of gold.

Current Account Deficit of India

14

Source: Page 29, An Investors Guide to the Gold Market, Gold

World Council

YEAR

GOLD PRICE( 10 gms )/1000

CAD % of GDP

2000

4.4

-0.7

2001

4.3

-1

2002

4.99

0.3

2003

5.6

1.4

2004

5.85

1.5

2005

0.1

2006

8.4

-1

2007

10.8

-0.7

2008

12.5

-2.5

2009

14.5

-1.9

2010

18.5

-3.2

2011

26.4

-3.4

2012

31.799

-5

2013

30.03

-2.6

2014

26.287

-1.7

2015

26.214

-1.4

Current Account Deficit of India

15

Gold Price vs CAD

GOLD PRICE( 10
gms )/1000
CAD % of GDP

10 11 12 13 14 15

Year 200X

Graph is a Bar Chart of Gold Prices and CAD as a % of GDP from 2001-15

As historically in India, it has been well established that increasing duties and restrictions
excessively without addressing the market demand only leads to a flourishing black market.
Policy makers need to recognize that economic incentives constitute only one part of a
solution to a complex problem. The key is in understanding the underlying causes to the
external symptom of an obsession with gold.
1. Inflation Rate
One of the prime reasons for the surging demand for gold is the high inflation rate in the
Indian economy coupled with the lack of financial instruments providing good returns in real
terms available to the average citizens (particularly the rural population).
2. Illegal Trade and Corruption
Apart from investing in land, tax evaders and other individuals who acquire wealth illicitly
choose to extensively invest in gold and diamonds as these commodities are easy to hide and
liquidate.
3. Lack of understanding and access:

Current Account Deficit of India

16

Apart from the high inflation rate reducing the appeal of the available financial instruments,
the lack of access and understanding of these financial instruments is another cause for the
high demand for gold. Investing in gold could also be seen as a hassle free option as there
wont be any red tape involved in the financial transaction.

Energy Consumption
According to the 12th Plan issued by the Planning Commission, India relies significantly on
the external sector by importing about 37% of its energy requirement as domestic production
is not and cannot meet the domestic demand in the short term. Indias import bills for energy
imports have been soaring due to the compounding effect of higher prices and higher
consumption. As energy is a fundamental input for a growth engine, domestic demand for
energy tends to be price inelastic (especially when it is artificially regulated). The 12th Plan
states that if India were to achieve a 9 % growth rate, the growth rate of commercial energy
supplies has to be around 6.5 7.0 %. It must be emphasized that Indias reliance on imports
to meet domestic energy demands will increase as its domestic energy supplies are limited.

Nature of Foreign Investments funding the Deficit

The nature of the foreign investments that have been financing Indias current deficit is a
cause for concern. India has a lot of portfolio investment from foreign institutional investors
(FII) in its equity and debt markets. The more sustainable foreign direct investment isnt
playing as much of a role as it should in Indias capital account. Having a high magnitude of
portfolio investment financing the current account deficit leaves the economy vulnerable to
sudden capital outflows. A sudden outflow can cause precarious fluctuations in the domestic
equity and bond markets as well as cause a rupee-depreciation.

Crude oil
Crude price is trading below the $100 psychological level. As everyone knows Crude oil
prices play a very significant role on the economy of any country. Indias growth story hovers
around the import of oil as India imports 70% of its crude requirements. Any negative change
in the crude oil price has an immediate positive impact on the increment in the GDP and IIP.
A one-dollar fall in the price of oil saves the country about 40 billion rupees. That has a threefold effect spread across the economy.

If the average fall in oil prices is about $4 per barrel in 2014-15, the trade deficit will
shrink by about $3 billion. In the April-June quarter, the current account deficit had
dropped to $7.5 billion, mainly due to customs duty on gold imports. Add to that the
fall in oil prices and the current account deficit should come down further and harden
the rupee against the dollar.

The fall in international oil prices will reduce subsidies that help sustain the domestic
prices of oil products. Petrol prices are already decontrolled. The more commonly
used diesel has been subject to staggered deregulation since September 2012.

Swinging from a persistent current account deficit, India could well be on the path of moving
into surplus, thanks to falling crude oil prices.
India imports nearly two-thirds of its crude oil requirements spending $130 billion annually
to meet its burgeoning oil demand. The countrys current account deficit had narrowed to 0.2
percent of the gross domestic product in the January-march quarter as oil prices slumped, and

Current Account Deficit of India

17

foreign investments flowing into the country remained steady. The fall in oil price alone
helped India to narrow its trade deficit in the January-March period to $31.7 billion compared
to $39.2 billion a quarter earlier.
Current account, which is an indicator of the countrys economic health, is the aggregate of
the balance of trade, net overseas income, and net transfers. While a positive current account
indicates that the nation is the lender, a negative current account suggests that the country is a
borrower.
Current account deficit is estimated to be around 1.5 percent of the GDP in the current fiscal
mainly due to lower oil prices, the Reserve Bank had said in June.
YEAR

Crude Oil Prices ( US $)

CAD % of GDP

2000

53.77

-0.7

2001

96.29

-1

2002

105.87

0.3

2003

109.45

1.4

2004

107.46

1.5

2005

77.38

0.1

2006

60.86

-1

2007

94.1

-0.7

2008

69.04

-2.5

2009

61

-1.9

2010

50.59

-3.2

2011

36.05

-3.4

2012

28.1

-5

2013

24.36

-2.6

2014

23.12

-1.7

Current Account Deficit of India

18

Crude Oil Price vs CAD

Crude Oil Prices ( US $)

CAD % of GDP

With the oil demand going downhill, the price of the US-benchmark West Texas Intermediate
has lost more 30 percent in the past two months, touching its lowest level since 2009.
Meanwhile, The Organization for Petroleum Exporting Countries which accounts for
around 40 percent of the worlds crude oil production --- has been refused to cut its output.
Some analysts expect oil prices to fall further as Iran, estimated to be sitting on 40 million
barrels of crude oil, is on the verge of entering the global oil market.
Irans nuclear accord and relaxing of oil sanctions by western powers by late 2015 could
shore up Irans output by 100,000 barrels a day. A record output from the US, Russia, and the
Middle East will continue to put downward pressure on crude prices.
Credit rating firm ICRA had estimated that for every $1 decline in crude oil prices, India is
expected to save Rs 6,500 crore ($993 million). With a global crude oversupply of 2 million
barrels a day and additional supplies expected from Iran, oil prices will continue to be weak,
it noted.
The cost of oil could be a key factor in helping Indias GDP growth rate to expand to around
6.3 percent in 2015-16 compared with an estimated 5.6 percent in the year earlier. A $50 drop
in crude prices equals a saving of about 2.5 percent of GDP in Current Account Deficit.
If oil price continues to fall, India could start the process of deregulating its oil price
altogether. The fall is expected to ease the governments subsidy bill. While the global crude
price has declined by around 60%, fuel prices in India have declined by a mere 14 percent
because the government had increased taxes on fuel thrice since November.
A fall in global crude oil price could have a soothing effect on inflation. However, the
soothing effect on inflation may not be strong enough because the consumption of oil in
industry is not that high except in the manufacture of certain products like carbon black.
Transport costs in India have decreased on the back of cheaper fuel with the Wholesale Price
Index rising only 0.11 percent since December.

Current Account Deficit of India

19

Linear Regression
Regression Statistics
R
0.80
R Square
0.64
Adjusted R Square
0.59
S
111.97
Total number of observations
16.00
CAD (% of GDP *50) =- 154.8895 - 0.4693 * GOLD PRICES ( US$) + 2.1038 * Crude Oil Prices ( US $)
ANOVA
d.f.
Regression
Residual
Total

2.00
13.00
15.00
Coefficients

Intercept
-154.89
GOLD PRICES ( US$)
-0.47
Crude Oil Prices ( US $)
2.10
T (5%)
2.16
LCL - Lower value of a reliable interval (LCL)
UCL - Upper value of a reliable interval (UCL)

SS
295587.34
162987.66
458575.00
Standard Error
199.98
0.35
1.86

MS
147793.67
12537.51

LCL
-586.91
-1.22
-1.91

F
11.79

UCL
277.13
0.28
6.12

p-level
0.00

t Stat
-0.77
-1.36
1.13

plevel
0.45
0.20
0.28

Current Account Deficit of India

20

Current Account Deficit of India

21

REGRESSION MODEL

GOLD PRICES ( US$)

Crude Oil Prices ( US $)
CAD (% of GDP *50)

Current Account Deficit of India

22

YEAR

GOLD PRICE( 10 gms in

1000)

Crude Oil Prices ( US

$)

CAD % of GDP

2000

4.4

53.77

-0.7

2001

4.3

96.29

-1

2002

4.99

105.87

0.3

2003

5.6

109.45

1.4

2004

5.85

107.46

1.5

2005

77.38

0.1

2006

8.4

60.86

-1

2007

10.8

94.1

-0.7

2008

12.5

69.04

-2.5

2009

14.5

61

-1.9

2010

18.5

50.59

-3.2

2011

26.4

36.05

-3.4

2012

31.799

28.1

-5

2013

30.03

24.36

-2.6

2014

26.287

23.12

-1.7

2015

26.214

27.6

-1.4

Current Account Deficit of India

23

Comparison of Indias CAD with Other economies

In an attempt to understand the situation of other emerging economies, we have studied the
CA performance of these economies. Comparison has been drawn between India and other
BRICS countries (Brazil, Russia, China, South Africa,) on the basis of their trade deficit.
Among these BRICS nations, it has been found that within the timeline from 1987 to till date,
China has always had a Current Account Surplus which is increasing with time unlike India
or other BRICS nations. Hence, there seemed to be a vast structural difference in India and
China. So, in our study we didnt go much deeper into the components of Chinas current
account. For all other nations, which have had a Current Account Deficit was analysed in
detail. The conclusion of our analysis for these nations is as follows
Russia
Strong CA to the strong oil backed export sector. The current account has never been in
deficit in the past 2 decades but the surplus has been decreasing gradually and it is expected
to be in deficit by 2015. Our analysis has shown that Slowdown of Oil exports and increasing
pace of Invisibles is the root cause of the decreasing surplus.
South Africa
Starting from 2003, it has experienced the longest and most-pronounced deficits. The
breakdown of the current account into its major components indicates that from a trade
perspective, the main contributor to the current account deficit has been the decline in the
trade balance, whereas, the deficit on the services and income balance has not helped in
neutralizing this effect as it has been negative throughout the sample period.
Brazil
CA performance of Brazil has been mixed when viewed from 1980. On an average, the
economy had a deficit of nearly one Billion dollars since then. The CA reached surplus
briefly prior to the financial crisis but has been in deficit ever since. We have observed that
falling exports are the main reason for increasing CAD. So, summarizing the cross country
comparison, we can take it that other emerging nations also have been under CA stress, like
India, but for many varying reasons. Hence it appears that there is no across the board
solution for the current problems of India and the only way forward is to forge its own way.

Recommendations
Our analysis so far has shown that increasing POL, Gold & Silver are the root causes for
deteriorating CAD. Decreasing demand for exports has been a common trend through the
world since the financial crisis of 2008. This slowdown is evident from slowing growth of
export based economies like China and commodity based economies like Brazil, Turkey etc.
Hence export expansion is not a reliable option for reducing the CAD. Hence, we believe that
import substitution is the only credible way for tackling CAD. Consecutively, our
recommendations aim at reducing the imports of the major contributors for CAD, POL and
Gold & Silver.
Tackling the Energy Problem

Current Account Deficit of India

24

Energy prices in India continue to be heavily deflated due to subsidies from the Government.
It is imperative to recognize that rational pricing of energy is the only way to manage demand
and have a healthy supply side response. Raising the prices of energy to reflect the global
energy prices will incentivize consumers to economize their energy consumption. It will also
allow the expansion of domestic supply by allowing companies relevant to energy production
to expand by curbing the losses imposed by subsidized energy production and registering
profits that can be used for investment in the energy sector. The Integrated Energy Policy
approved by the Government in 2009 is aimed at equalizing domestic energy prices with the
prices of imported energy, while allowing for targeted subsidy to the needy and poor.
However prices continue to be below par due to political pressures. Note that the 12th five
year plan rightly states that a long term strategy to bring about a calibrated shift to sustainable
sources of energy should be etched out by the Government in light of the various
environmental crises the world faces due to unsustainable practices. As energy related
commodities constitute the most significant part of our imports, these reforms will be critical
in addressing the current account deficit in a sustainable fashion.
It must be noted that from a historical point of view there are two occasions that are relevant
to the current scenario. Firstly, the 1979 World Energy Crisis caused by Iran halting oil
exports in the aftermath of the Iranian Revolution caused the Indian rupee to devaluate by
about 125 % in the 1980s(7.85 rupees per dollar in the early 1980s to 18.00 rupees in the
late 1980s.) Secondly, the financial crisis of 1991 experienced in India was also a
consequence of a high current account deficit caused by a surge in oil prices due to the gulf
war, a fall in exports and capital outflows due to negative investor sentiment. There was a
major currency devaluation of about 50.00 % at this juncture as well. However note that the
foreign exchange reserves were much lower in 1991.
Projected Primary Commercial Energy Requirement
(Million tonnes of oil equivalent)
2010-11*
2016-17@
Oil
164.32
Of which imports
125.5 (76.4%)
Natural Gas & LNG
57.99
Of which imports
10.99 (19%)
Coal
272.86
Of which imports
54 (19.8%)
Lignite
9.52
Hydro
10.31
Of which imports
0.48 (4.6%)
Nuclear
6.86
Renewables
0.95
Total Energy
522.81
Total Imports
190.97
% of Total Energy
36.53
Source: The 12th Plan of the Planning Commission

204.80
164.8 (80.5%)
87.22
24.8 (28.4%)
406.78
90 (22.1%)
14.00
14.85
0.52 (3.5%)
9.14
1.29
738.07
280.12
37.95

One can thereby establish that tackling the energy problem should be the first priority in our
current agenda to achieve a sustainable and stable economy.
Tackling Gold

Current Account Deficit of India

25

The Government of India has increased import duties on gold substantially (upto 8.00% in
June, 2013) in an effort to curb its demand. In April, 2013, gold prices plummeted down due
to Cyprus plan to sell their bullion reserves in wake of their sovereign debt crisis. This in
turn caused a spike in the global demand for gold. The Government then took a series of
measures to further restrict the import of gold. The Reserve Bank of India has stated that they
are prepared to take much more drastic measures if the demand for gold isnt contained.
Expanding financial inclusion, increasing a savers access to financial products whilst
reducing inflation is imperative to reduce the demand for gold. The Reserve Bank of India
took a positive step in June, 2013 by introducing Inflation Indexed Bonds (IIBs) sold
through the IDBI (Industrial Development Bank of India) bank to wean investors away from
gold and real estate. However the IIBs are linked to the Wholesale Price Index as opposed to
the Consumer Price Index which is more relevant for investors.
Setting up of a Bullion Corporation
The idea of a Gold Bank was mooted by the then Finance Minister, Dr.Manmohan Singh, in
his budget speech in 1992. However, the proposal was not implemented. The RBI Working
group recently suggested that the gold bank could be given powers to import, export, trade,
lend and borrow gold and deal in gold derivatives. Its role would be that of intermediary in
gold transactions, providing liquidity to holders of gold and gold loan providers
Tackling POL Imports
Transportation accounts for nearly 7% of annual petroleum consumption which is even
higher than the consumption for industrial purposes. So, in order to tackling POL imports, it
is inevitable that one deals with the excess demand from consumption due to transportation.
This can be achieved by manipulating 2 levers that control the overall consumption. They are
Per capita Kilometers travelled (Subsidising Electric & Hybrid Vehicles)
The biggest contributor for increasing demand from transportation is personal transport,
mainly cars. So, in order to decrease the POL imports, alternatives for petroleum products
should be encouraged. We believe that India should incentivize usage of electric vehicles in
the country by providing subsidies/tax cuts etc.
Fuel consumed per Kilometer (Introduction of CAFE norms in India)
Corporate Average Fuel Economy (CAF) is an internationally followed measure to ensure
that the automobile manufacturers strive to improve the fuel efficiency of their vehicles. The
Obama administration has been pushing aggressively for improving the CAF standards in
the U.S. CAF regulation in U.S stands at 36 Miles Per Gallon (MPG). In India, no such
norms have been established. Given that many of counter parts automobile manufacturers in
the U.S are striving towards improving the fuel efficiency, India should push the domestic
manufacturers and all other entities present in India to adopt the CAF Norms.
Containing the Inflation Rate
1. Increasing domestic productivity to address rising demand pressures in protein food
commodities and so on.
2. Tackling the fiscal deficit by reforming unsustainable populist Government policies (such
as the energy policies, pricing policies, etc.), increasing tax revenue and addressing

Current Account Deficit of India

26

unproductive Government expenditure. Reducing tax evasion and Government corruption is

hinged on bringing about a series of reforms based on reforming the political and social
framework that incentivizes and rewards such detrimental actions. Inefficiencies in the public
sector can be addressed by privatization in certain sectors and increased accountability. In the
case of sectors like healthcare and education, it must be emphasized that complete
privatization can be inimical to the interests of a majority of India citizens which in turn will
affect sustainable growth.
3. Reducing the liquidity in the market to trigger currency appreciation (and hence deflation)
through a series of measures taken by the Reserve Bank of India. They are,

Increasing the Cash Reserve Ratios (CRR): CRR is the ratio of the total deposits of
a bank in India which is kept with the RBI in cash form. As part of the fractional
reserve systemii, the higher the CRR, the lower the money supply in the economy.
Increasing the Statutory Liquidity Ratio (SLR): The SLR is the ratio of the liquid
assets that must be held by a bank to the Net Demand and Time Liabilities (NDTL)
held by the bank. Simply put the NDTL is the total liability of the bank to its
customers (through deposits, bank accounts, saving certificates etc). Increasing the
SLR reduces the amount of money the bank can pump into the economy.
Interest Rates Associated with the Liquidity Adjustment Facility (LAF). LAF is a
monetary policy which allows banks to borrow money through repurchase
agreements. The collateral used for these operations are Government of India
securities.
Increasing the Reverse Repo Rate: A Reverse Repo operation is when the RBI
borrows money for a short term from commercial banks by lending securities. The
interest rate paid by the RBI is the Reverse Repo Rate. Banks always lend to the RBI
since it is the safest entity to lend money to. So a higher Reverse Repo Rate leads to
banks parking more of their money with the RBI thereby sucking the liquidity out of
the economy.
Increasing the Repo Rate: A repo operation is when commercial banks borrow money
from the RBI to meet short term requirements by lending securities. The interest rate
paid by the commercial banks is the repo rate. A higher repo rate causes banks to
borrow lesser money from the RBI reducing the liquidity in the economy.
Attracting Foreign Direct Investment
It is imperative to clear up supply side bottle necks and provide economic incentives that will
attract the more sustainable foreign direct investment to the country to finance the current
account deficit in the short term, as the structural shift to reducing the current account deficit
significantly will take time. The Government needs to be on the path of fiscal consolidation
to bring about stable macro-economic conditions in the Indian economy to attract investors.