Current Account Deficit (CAD)

If an economy is running a current account deficit, it is absorbing (absorption = domestic consumption + investment + government spending) more than that it is producing. This can only happen if some other economies are lending their savings to it (in the form of debt to or direct/ portfolio investment in the economy) or the economy is running down its foreign assets such as official foreign currency reserve.

India’s current account deficit in the January-March 2021 quarter stood at $8.1 billion compared to a surplus of $0.6 billion in the same quarter a year ago.

Current Account Deficit (CAD) and other economic terms are important from the IAS Exam perspective as questions based on the same can be asked in the prelims or the mains examination.

In this article, we shall discuss at length what is current account deficit, what is its significance and more. All government exam aspirants must review the information discussed further below in the article.

What is Current Account Deficit?

The current account measures the flow of goods, services and investments into and out of the country. The country runs into a deficit if the value of goods and services we import exceeds the value of those we export. The current account includes net income, including interest and dividends, and transfers, like foreign aid.

A nation’s current account maintains a record of the country’s transactions with other nations, it comprises of following components:

• Trade of goods,
• Services, and
• Net earnings on overseas investments and net transfer of payments over a period of time, such as remittances

A country with rising CAD shows that it has become uncompetitive, and investors may not be willing to invest there. In India, the Current Account Deficit could be reduced by boosting exports and curbing non-essential imports such as gold, mobiles, and electronics.

A current account deficit is not always a problem. The Pitchford thesis states that a current account deficit does not matter if it is driven by the private sector. It is also known as the “consenting adults” view of the current account, as it holds that deficits are not a problem if they result from private sector agents engaging in mutually beneficial trade.

What is the formula to calculate Current Account Deficit (CAD)?

The formula to calculate CAD is:

Current Account = Trade gap + Net current transfers + Net income abroad
(Trade gap = Exports – Imports)

Why does CAD matter?

The current account deficit is an important signal of competitiveness and the level of imports and exports. A large current account deficit usually implies some kind of disbalance in the economy, which needs correcting with the depreciation in the exchange rate and/or improved competitiveness over time.

A current account deficit is financed by attracted capital inflows, for example, foreigners buying domestic assets. This means foreigners hold a greater claim on assets and dividends. The benefit of a CAD is that it allows higher levels of domestic consumption because we are buying from abroad.

Aspirants can also go through the detailed UPSC Syllabus at the linked article and accordingly start their preparation.

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