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BoP account for India typically comprises of the following standard components
a) Current Account b) Capital & Financial Account c)Errors and Omissions d) Change in Foreign
Exchange reserve. Theoretically, BoP for any economy is zero i.e. the current account should
balance out the Capital/finance account. However, this does not happen in reality. Let us
analyze a bit closely the current Accounts.
Under current account of the BoP, transactions are classified into merchandise (exports and
imports) and invisibles. As the country participates in global trades of good and services with
other countries, investors and industries from one country invest capital and resources in
foreign countries, there is bound to be a strong correlation between the Gross domestic
Product (GDP) of a country with its Current Account. Let us see how with an algebraic
expression.
Widening of trade deficit due to a sharper decline in exports relative to decline in imports.
This was primarily attributed to the sudden surge of gold and oil imports which caused a
drain on Current account
Net services import recorded a rise mainly on account of travel, transport, software services
and financial services
Rise in remittances
Let us examine why gold imports surged. In India, traditional motive of gold demand has been
for jewelry. However, apart from an unusually strong cultural affinity for this yellow metal, gold
also seems to have become a safe investment asset and a hedge against inflation in India. To
curb this surge government decided to impose import duty on gold imports. Agents expecting higher
future duties for forwarded gold imports raised CAD.
Source: FT
Second addition to the trade deficit is due to oil imports. India has always been a net importer
of oil and oil imports are one of the biggest chunks of our import bill. As we can see the effect
of raising oil imports on Current account. Volatility in international oil prices and domestic
subsidies on oil products exert a lot of pressure on import bill. Hence there is a strong need to
align the domestic pricing of oil with international oil prices to rationalize the oil consumption.
Second component of Indias CAD comprises of net invisibles which can further be classified
into three components. The first is Services comprising travel, transportation, insurance,
government not included elsewhere (GNIE), and miscellaneous. Miscellaneous services include
abroad will get into trouble, and monetary easing may not yield any fruitful result. The
economy may go into a tailspin.
Let us now analyze from savings and investment perspective. As seen in equation (5) CAD also
reflects the balance of national savings and investments in the economy. The role of savings
here is crucial. Adequate savings is required to boost the corporate investment which in turn
increases economic growth. i.e investments will be financed by savings which include
Government savings and Private savings (Aggregate income minus aggregate expenditure). In
the equilibrium following identity should hold
Gross domestic investments = Private savings +Gov. savings + Foreign Savings (6)
i.e. all real investment in factories, housing, capital spending, and so forth has to be financed by
savings. Note here that foreign savings is considered as flipside of Current Account balance in
the national accounts identity. If you stare at equation (6) a bit, youll realize that it is nothing
but a rearrangement of components in equation (5). So another interpretation of Current
account deficit would be, we are importing savings from other countries to finance our
domestic investments.
CAD in India is reflective of low savings rather than high investment. India has been witnessing
a savings investment gaps on account of low private (household+corporate) savings. The
widening non-household saving-investment gap rose to a historical high of -7.8 per cent of GDP
in FY12 after rising to -3.5 per cent in FY11. This could mean RBI will draw down on forex
reserves to fund deficits and monetize the governments deficits through open market
operations (http://www.business-standard.com/article/opinion/fall-in-savings-must-bearrested-before-rate-cuts-112031600029_1.html).
Anticipating a worsening CAD, the government has been working on incentivizing foreign capital inflows
into the country. To enhace external debt flow, finance minister P. Chidambaram announced a
rationalization in foreign investment limits in the government securities and corporate bond market by
merging all existing sub-limits under two broad categories from 1 April.
These numbers reflect that the rupee is becoming a weaker currency. It may in turn fuel gold purchases,
which could again worsen the trade deficit. Spurring exports may be the only option left with the
government since it has not been able to curb imports, especially gold.
The BoP data showed that CAD was financed through capital flows, and there was no drawdown on
foreign exchange reserves. This was mainly on account of the surge in foreign portfolio investments,
which rose to $8.6 billion from $1.8 billion in the year-ago period.
The large costs to the economy of a possible balance of payments crisis due to a sudden stop can be
avoided if public authorities pay certain small price up front for a credit line from IMF.