What a widening CAD portends for the economy

India’s current account deficit (CAD) widened to a four-quarter high at 2.4% of gross domestic product (GDP) in the April-June period from 1.9% in the January-March quarter of 2017-18.

The weakening rupees against the US dollar and high crude-oil prices in the international market have swelled the current account deficit in the first quarter. The domestic currency has been Asia's worst performing currency so far this year. Current account deficit (CAD) showed a slight improvement in the June quarter, coming at 2.4 per cent of the GDP. The improvement has come despite a steady decline in the rupee exchange rate against the dollar and higher crude oil prices.

There was a depletion of $11.3 billion of the foreign exchange reserves (on Bop basis) in the first quarter of this year as against an accretion of $11.4 billion. On a balance of payments basis (i.e., excluding valuation effects), the foreign exchange reserves decreased by $11.3 billion during April-June 2018 as against an increase of $ 11.4 billion during April-June 2017. The foreign exchange reserves in nominal terms (including valuation effects) decreased by $18.8 billion during April-June 2018 as against an accretion of $16.6 billion in the preceding year. From strong capital account flows of $25 billion in Q4FY18, the flows in Q1FY19 have dropped to just $5.2 billion. Net FDI flows were, however, reasonably good; at $9.7 billion, these were higher than the levels in Q4FY18.

Exports are expected to do better with some help from the weaker rupee, but may see only a modest improvement since global trade could slow down in the wake of the tariff war between the US and China. Countries like India could be caught in the crossfire; at this point, it doesn’t look like exports will top last year’s $309 billion by too much.

Why is CAD rising?

Tensions in the Gulf region, US sanctions on Iran and the instability in key oil exporting nation Venezuela pushed global crude prices above the $75-a-barrel mark. Petroleum ministry data shows that while India’s oil imports rose 5.6% in Q1FY19, oil price in the Indian basket surged 46% in that time. The China-US trade war may hamper export growth, while rising investment demand will lead to more imports. This may further widen CAD in FY19.

Impact of Widening Current Account Deficit

Impact of the rupee's weakening will be diverse and will also depend on issues such as a particular company's reliance on exports, its cost base, and its exposure to pricing on international markets.

• It will have an adverse impact particularly on those entities that generate revenue in rupees but rely on US dollar debt to fund their operations and have significant dollar-based costs, including capital expenses.
   
• Higher CAD will put the rupee under pressure and may raise the cost of overseas borrowing.
   
• Experts cite high crude oil prices, boost in non-crude and non-gold imports as major reasons for a high CAD.
   
• Inflation will rise, prompting higher interest rates

Spillover effect

India’s widening current account deficit and the depreciating rupee were factors behind Monday’s market meltdown. According to RBI data released on Friday, the country’s CAD had widened to $15.8 billion compared to $15 billion in the year-ago quarter. The Indian rupee meanwhile touched an all-time low of ?72.67 against the dollar, becoming the worst performing emerging markets currency in Asia. The rupee has depreciated nearly 13% since the beginning of the year. 

An escalating trade war between the US and China continues to weigh down on Asian stocks. On Friday, US President Donald Trump warned the country could move “very soon” to bring another round of tariffs on Chinese imports, which would bring tariffs on all of Chinese imports into the US, intensifying the trade war between the two countries.

One of the primary reasons for RBI’s reluctance to aggressively intervene to support the plunging rupee is to check the sharp rise in imports especially that of electronic items like mobile phones, battery chargers and cameras that contributed significantly to widen the country’s trade deficit.