In June this year, the Finance Ministry spoke at length about the problem of “twin deficit” in India, which essentially stands for fiscal deficit along with current account deficit (CAD). With ballooning trade deficit, the current account deficit of India is also widening. According to a latest Reuters Poll, India's current account deficit likely widened to its highest in nearly a decade in the April-June quarter, driven by soaring global commodity prices and the biggest capital outflows since the global financial crisis of 2008.
Now, with the Indian rupee having breached a record 81 to the US dollar, coupled with a worsening trade gap, worries over the size of the current account shortfall for Asia's third-largest economy, which is gnawing at investor confidence for months, are set to intensify. According to the brokerage house Motilal Oswal Financial Services, India’s current account deficit will likely widen to a decadal high of 3.8 per cent of gross domestic product (GDP) in 2022-23 from 1.2 per cent last year. It has estimated the CAD to widen by 3.7 per cent of GDP in the first quarter and to peak at 5.5 per cent in the second quarter amid persisting global headwinds.
“We really need to focus on CAD; 3 per cent of the GDP is a high limit. We really need to go down the point as some elements that have contributed to the increase in our [forex] reserves, are volatile in nature. And those elements are the ones which really pull down the exchange rate,” said noted economist and former RBI governor C. Rangarajan.
What does rising CAD mean for the nation?
CAD, as of now, is driven by the ballooning trade deficit in India. With depreciating rupee, the imports gets costlier, therefore, for a country like India, which imports costly items and commodities like crude oil, semiconductors and electronic goods, the burden on the exchequer is rising and this is pushing the current account deficit higher. Also, worsening CAD puts pressure on inflow under the capital account.
So, under the current scenario, the current account deficit is likely to balloon, and as a result of this, the demand for foreign currency will also rise, leading to depreciation of the home currency. And the depreciating currency and rising current account deficit will lead to capital flight away from India. Another aspect of depreciating rupee is the rise in imported inflation, which in turn, leads to an uptick in broad-based inflation in India. Thus, to curb the volatility, the RBI also ensures that the rupee does not fall sharply, as this could increase the inflation in the economy. It conducts periodic ‘intervention’ in the foreign exchange markets by selling foreign currency and buying the rupee.
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