In News:

• India’s Current Account Deficit (CAD) for the April-June quarter (Q1 FY22) widened to 2.8% of the Gross Domestic Product (GDP) – the highest in four years, but lower than 3-3.5% forecast by many economists.

What’s in today’s article:

• Exchange rate of Rupee (Imports, Exports)
• Balance of Payments (Capital account, Current account)
• Current Account Balance (Trade account, Invisibles account, Deficit, Surplus, etc.)
• News Summary (Reasons for high CAD)

Exchange rate of Rupee:

• Every day, Indians and Indian entities — such as firms and governments — import foreign goods and services, export domestic goods and services, receive investments from abroad, and make investments in other countries.
• Each of these transactions involves either a demand for foreign currency — for example, you need dollars to import something from the US or to invest in one of the US stock exchanges — or a demand for Indian currency (by the same logic).
• The interplay of these transactions decides the exchange rate of the Indian rupee vis-a-vis the foreign currency (say the US dollar).

Recording of Transactions:

• A notebook, or slate or ledger that records all of the above mentioned transactions is called the Balance of Payment (BoP).
• The BoP has two parts –
  • Capital Account:
    • This includes all types of trading in capital.
    • In other words, all investments and loans inside and outside the country are recorded here — for example, if an Indian firm invests money in the US to build a new company there, or if an Indian buys stocks on an American exchange.
    • This account comprises foreign direct investments, portfolio investments, etc. It gives a summary of the net flow of both private and public investment into an economy.
  • Current Account:
    • Here, all the trade in goods and services is noted down.
    • For example, if an Indian imports an American gadget or software made by an American company or if an American entity imports Indian steel or engages an Indian IT company to create a software.
  • The Current Account has two specific sub-parts:
    • Import and Export of goods — this is the “trade account”.
    • Import and export of services — this is called the “invisibles account”.

About Current Account Balance:

• It is possible that a country — say India — imports more goods (everything from cars to phones to machinery to food grains etc.) than it exports.
• In such a case, it would have a “deficit” on its trade account.
  • In other words, more money is going out of the country than coming in via the trade of physical goods.
• However, India could be enjoying a “surplus” on the invisibles account.
  • This may happen because its software industry is very capable, efficient and competitive, and exports lots of software solutions.
• The net effect of this surplus (or deficit) on the invisibles account and the deficit (or surplus) on the trade account is called the current account balance.

India’s Current Account Deficit:

• In case of India, there is a huge trade deficit and a smaller surplus on the invisibles hence what we have is an overall deficit on the current account — or Current Account Deficit.
• In essence, having a CAD or a deficit on the current account implies that, in monetary terms, India imports more goods and services than it exports.
• This, in turn, implies that the demand for the foreign currency (say the US dollar) is more than the demand for the Indian rupee.

News Summary:

• India’s current account deficit (CAD) for April-June quarter (Q1) widened to 2.8% of the GDP – the highest in four years.
• In absolute terms, the CAD for the Q1 was USD 23.9 billion, up from USD 13.4 billion in preceding quarter.

Reasons for increased CAD:

• While India’s trade deficit has widened, a lot of support has come from Invisibles account.
• With both IT industry and foreign remittances witnessing higher net inflows of USD 30 billion and USD 23 billion, respectively.
  • Foreign remittance is a transfer of money from a foreign worker to their family or other individuals in their home countries.
• India’s export earnings have also started falling.

Capital Account

• Capital flows from foreign investors, which helped to ensure the Balance of Payments, have also declined after global funds turned risk-averse after the US Federal Reserve System increased the interest rate.
  • Federal Reserve System is the central bank of the US.
• Net foreign portfolio investment saw outflows of USD 14.6 billion, versus inflows of USD 0.4 billion in Q1 FY22.