Current account deficit narrows sharply to $4.2 bn in Q3

• India’s current account deficit (CAD) narrowed sharply to $4.2 billion (0.9 per cent of gross domestic product (GDP)) in the third quarter of the current financial year from $31.9 billion (6.5 per cent of GDP) in the third quarter of 2012-13. 
• This is also lower than $5.2 billion (1.2 per cent of GDP) in the second quarter of 2013-14.
• “The lower CAD was primarily on account of a decline in the trade deficit as merchandise exports picked up and imports moderated, particularly gold imports,” the RBI said in a release.

Merchandise exports

• On balance of payments (BoP) basis, merchandise exports increased by 7.5 per cent to $79.8 billion in third quarter of 2013-14 (3.9 per cent in third quarter of 2012-13) “on the back of significant growth especially in the exports of engineering goods, readymade garments, iron ore, marine products and chemicals.”
• On the other hand, merchandise imports at $112.9 billion, recorded a decline of 14.8 per cent against an increase of 10.4 per cent. 
• “The decline in imports in the third quarter was primarily led by a steep decline in gold imports, which amounted to $3.1 billion as compared to $17.8 billion in the third quarter of 2012-13 and $3.9 billion in the second quarter of 2013-14,” the RBI added.
•  As a result, merchandise trade deficit (BoP basis) contracted by around 43 per cent to $33.2 billion in the third quarter of 2013-14 from $58.4 billion a year ago.

FDI

• In the financial account, on net basis, foreign direct investment and portfolio investment recorded inflows of $6.1 billion and $2.4 billion, respectively in the third quarter of 2013-14. 
• Within portfolio investment, the debt segment showed net outflow which, however, was offset by higher net inflows of equity of $6.2 billion. Net inflows of NRI deposits amounted to $21.4 billion as compared to $2.7 billion. 
• “A sharp increase in NRI deposits was on account of fresh FCNR(B) deposits mobilised under the swap scheme offered by the Reserve Bank during September-November 2013.”

Forex reserves

• On BoP basis, there was a net accretion of $19.1 billion to India’s foreign exchange reserves in the third quarter of 2013-14 as compared to a drawdown of $10.4 billion in the preceding quarter.
• The RBI said that the turnaround in export growth and decline in imports from July 2013 onwards led to a sharp reduction in the trade deficit to $116.9 billion in April-December 2013 from $150 billion in April-December 2012.
• Contraction in the trade deficit, coupled with a rise in net invisible receipts, resulted in a reduction of the CAD to $31.1 billion (2.3 per cent of GDP) in April-December 2013 from $69.8 billion (5.2 per cent of GDP) in April-December of 2012, the RBI added.

ABOUT Current Account Deficit (CAD):

Definition: A current account deficit is when a country’s government, businesses and individuals imports more goods, services and capital than it exports. That’s because the current account measures trade, as well as international income, direct transfers of capital, and investment income made on assets, according to the Bureau of Economic Analysis. When those within the country rely on foreigners for the capital to invest and spend, that creates a current account deficit. Depending on why the country is running the deficit, it could be a positive sign of growth, or it could be a negative sign that the country is a credit risk.

What Are the Components of a Current Account Deficit?

• The largest component of a deficit usually a trade deficit. This simply means the country imports more goods and services than it exports. 
• The second largest component is usually a deficit in the net income. This occurs when the country exports dividends on stocks, interest payments made on financial assets, and wages paid to foreigners working in the country. If all payments made to foreigners are greater than the interest, dividends and wages made by foreigners to the country’s residents, the deficit will rise.
• The last component of the deficit is the smallest, but often the most hotly contested. These are direct transfers, which includes government grants to foreigners. It also includes any money sent back to their home countries by foreigners

What Causes a Current Account Deficit?

• Countries with current account deficits are usually big spenders, but are considered very credit worthy. 
• These countries’ businesses can’t borrow from their own residents, because they haven’t saved enough in local banks. 
• They would prefer to spend than save their income. Businesses in a country like this can’t expand unless they borrow from foreigners. 
• That’s where the credit-worthiness comes into the picture. 
• If a country has a lot of spendthrifts, it won’t find any other country to lend to it unless it is very wealthy and looks like it will pay back the loans.

What Are the Consequences of the Current Account Deficit?

• In the short-run, a current account deficit is mostly advantageous. 
• Foreigners are willing to pump capital into a country to drive economic growth beyond what it could manage on its own.
• However, in the long run, a current account deficit can sap economic vitality. 
• Foreign investors may begin to question whether economic growth can provide an adequate return on their investment. 
• Demand could weaken for the country’s assets, including the country’s government bonds. 
• As this happens, yields will rise and the national currency will gradually lose value relative to other currencies.