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What Is Current Account Deficit?

IndianMoney.com Research Team | Updated On Tuesday, January 22,2019, 10:56 AM

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What Is Current Account Deficit?

 

 

What is current account deficit?

Current account deficit or CAD, is an assessment of a country's foreign trade, in which the value of goods and services imported is greater than the value of goods and services exported. Current account represents a country's foreign transactions. Current account includes net income like interest, returns including dividends and so on, and net transfers including foreign aid extended.

CAD represents negative foreign sales of a country. If the current account balance is less than zero, then it is said to be in deficit, if not, it is in surplus. Developed countries like United States usually run current account deficits, while emerging countries often run current account surpluses. China has a trade surplus with the USA.

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Current account deficit India

India traditionally has current account deficit, as the value of its imports is way higher than the value of its exports. India mainly imports crude oil from gulf countries. India is one of the top 5 crude oil importers. Gold is another commodity that is imported in a large quantity.

India mainly exports gems, mineral fuels, machinery and organic chemicals. The Indian export business is not something to boast of. The Indian export base is facing stiff competition from Chinese counterparts who outplay Indian products when it comes to pricing. India is improving trade relations with its neighboring countries to promote exports.

India mainly exports its products to USA, gulf countries and UK. Indian products are not getting bigger market share in foreign countries due to their internal policies which is curbing down globalization and stressing on promoting domestic goods and services over foreign goods and services.

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What Is Current Account Deficit?

Components of current account deficit

  • Export and import of goods: A good part of the transactions made in foreign trade is in the form of export and import. Settlements made for imports are considered negative and settlement made for exports are considered positive.
  • Export and import of services: This includes a wide range of non-factor services that are imported and exported. These are not physically visible. Payments are made and received for imports and exports respectively.  Services are generally of three kinds:

i) Shipping

ii) Insurance

iii) Banking

  • Unilateral or unrequited transfers to and from abroad: This includes giving away donations, gifts and all forms of one-way transactions which have no returns in the form of service or money. Receipt of unilateral transfers is considered positive and payment of unilateral transfers is considered negative.  

Causes of current account deficit:

  • Overvalued exchange rate: If the currency is overvalued, then the imports become cheaper, thereby increasing the quantity of imports. This results in exports turning out to be uncompetitive which reduces the quantity of exports.
  • Economic growth: If there is an increase in the national income, then the individuals would have more money at their disposal to buy goods and services. If the domestic producers don’t meet the demand then the country is forced to import goods and services which impacts current account deficit.
  • Decline in competitiveness of export sector: If the country faces stiff competition which it can’t keep up, then its counterparts will fare better thereby reducing the income generated by the export sector of the country.
  • Inflation: Inflation is when money loses value against goods. This happens when the demand is more and supply is less or where more money chases less goods.
  • Recession in foreign countries: If the country to which your products are exported is in a financial crisis, then there will be no demand for the products which hampers the export sector.

SEE ALSO: What is Interest Rate?

How to Reduce a Current Account Deficit?

  • Devalue the exchange rate: Cheaper exports and expensive imports will help current account deficit improve. This considers the demand for exports and imports are price elastic.
  • Imports more expensiveImports like petrol, food and raw materials will become costlier, thereby reducing the demand for imported goods and services due to devaluation.
  • Increased aggregate demand (AD): Devaluation will result in higher economic growth. In normal circumstances, higher AD is likely to increase real GDP and inflation.
  • Increase in export: New markets must be discovered for the products exported from the country. Settlements received for the exported products are considered positive for the current account deficit.
  • Become self sufficient: The Government must encourage domestic market to outplay the foreign products. This would reduce the quantity of imports.

What is the difference between a trade deficit and a current account deficit?

Trade balance is either surplus or deficit of a country that runs on exports and imports of goods and services with rest of the world.

Current account balance is the sum of trade balance and surplus or deficit of a country that runs on investment income from rest of the world.

Any surplus or deficit on the current account is matched by an equal and opposite balance on the capital account, reflecting an increase in net claims on the rest of the world for a country with a current account surplus or a decrease in net claims on the rest of the world for a country with a current account deficit.

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