Balance Of Payment: Current Account - Indian Economy
Introduction
A nation's short-term transactions, or the gap between savings and investments, are covered by the current account. Because of the real effects that the movement of goods and services has on income, output, and employment levels in the economy, these are often referred to as actual transactions.
The Balance of Payment Is What?
A country's people' transactions with the rest of the world for a predetermined amount of time, usually a year, are tracked by the balance of payments (BoP).
The BoP has two primary accounts:
• The current account
• The capital account
Current Account: The current account tracks commerce in services, transfer payments, and the exports and imports of goods.
Capital Account: The capital account keeps track of all domestic and foreign exchanges of assets including cash, securities, and bonds. Included are loans and investments made abroad.
A Current Account Is What?
• The flow of investments, goods, and services into and out of a nation is tracked by the current account.
• The nation runs a deficit if the value of goods and services imported exceeds the value of those exported.
• The current account comprises transfers like foreign aid as well as net revenue like interest and dividends.
• A country's transactions with foreign nations are recorded in its current account.
• Unilateral transfers, visible trade (goods exported and imported), invisible trade (services exported and imported), and investment income (revenue from items like overseas stocks or land) make up the current account.
• The current account balance also reflects the credit and debit of foreign exchange from these transactions.
• The balance of trade is used to approximate the current account balance that results.
Balance on Current Account
• In the current account, payments for imports of goods, services, and unilateral payments are recorded as debits, whereas receipts from exports of goods, services, and unilateral payments are recorded as credits or positive items.
• The difference between the credit and debit balances is the current account balance.
• When credit items outnumber debit items, a current account surplus results. It stands for the net foreign exchange inflow.
• India's current account in the balance of payments closed in a surplus of 0.9 percent of GDP in FY '21, for the first time in 17 years, as the trade deficit decreased due to a decline in pandemic-induced import demand.
• When debits outweigh credits, a current account deficit results. It represents the overall net outflow of foreign exchange.
Balance of Trade
• The most significant element of a country's balance of payments (BOP) is the balance of trade (BOT), which is the difference between exports and imports for a specific time period.
• A country experiences a trade deficit when it imports more goods and services than it exports in value, whereas a country experiences a trade surplus when it sells more goods and services than it imports.
Difference between Balance of Trade and Current Account
|
Parameter |
Balance of Trade (BOT) |
Current Account |
|
Components |
Includes only visible items. |
Includes both visible and invisible items. |
|
Coverage |
Narrow Concept. It is only a part of the current account |
Wider Concept. It includes BOT. |
Elements of Current Account
The following are the current account's principal elements:
Visible Trade: Imported and exported products
• The majority of international trade deals include the export and import of goods by a nation.
• While receipts from the export of commodities to other countries are displayed on the positive side or as positive things, payments paid for the import of goods from other nations are displayed on the negative side or as debit items.
• The trade balance, often known as the merchandise trade balance, is the difference between these exports and imports.
• The trade balance will be positive if exports outnumber imports and negative if imports outnumber exports.
Invisible trade (the export and import of services)
• It comprises, among other things, the export and import of services such as those related to information technology, banking, insurance, and advisory services offered to foreign nations, BPO, tourism, and outsourcing.
• The current account records the export of services as a credit and the import of services as a debit.
• It is referred to as "invisible trade" since both the export and import of services are invisible.
Transfers of Payments
• Gifts and donations, personal remittances, international assistance, charitable contributions, withdrawals of NRI deposits locally, and other one-way transfers are examples of transfer payments.
• Outgoing remittances are recorded as a debit to the current account, whilst incoming transfers are recorded as a credit.
Net Factor Income
• Net factor income includes dividend income from shares in overseas firms, revenue from international investments, income from foreign subsidiaries of companies, interest from loans and investments abroad, and other similar sources of income.
• Payments to overseas residents are recorded as a debit to the current account when they are made, while income from foreign sources is recorded as a credit.
Remittances
• By lowering the current account deficit, strengthening the balance of payments, and reducing dependency on external borrowing, remittances have a favorable effect on economic growth.
Current Account Deficit
• Consumption is equal to domestic consumption plus investment plus government spending when an economy has a current account deficit.
• This is only possible if other economies lend it their money (via direct or indirect investments in the economy) or if the economy is exhausting its foreign assets, such as its official foreign currency reserve.
• A rising CAD suggests that a nation has lost its competitive edge, and investors may be hesitant to make investments there.
• Not all current account deficits are detrimental. A current account deficit that is created by the private sector is unimportant since it results from agents in the private sector participating in commerce that is mutually beneficial.
• Current Account = Trade Gap (Trade Gap = Exports - Imports) + Net Current Transfers + Net Income Abroad
Significance
• A crucial indicator of competitiveness as well as the volume of imports and exports is the current account deficit.
• A significant current account deficit typically signals an economic imbalance that must be resolved over time by depreciating the currency and/or increasing competitiveness.
• The closing of a current account deficit requires luring capital inflows, such as foreigners investing in domestic assets. Foreigners now have a stronger claim to assets and dividends, according to this.
• The current account deficit enables higher levels of domestic consumption since we are purchasing from overseas.
Measures To Fund Current Account Deficit
• Diverse capital inflows, such as portfolio investments, external commercial borrowings, foreign direct investments, and NRI deposits, are used to finance current-account deficits. The local currency could be under strain if CAD receives insufficient funding.
• The greatest strategy to fill the current account deficit is via non-debt producing long-term inflows, like foreign direct investment. The stability of the external sector balance sheet may be threatened by erratic inflows, such as portfolio investments or "hot money."
• By raising exports and decreasing imports of non-essential goods like gold, mobile phones, and electronics, the current account deficit of India could be minimized.
Conclusion
India's current account deficit has lately increased after being in surplus for a while. The rupee's value against the US dollar has also significantly declined as a result of insufficient capital inflows. A CAD of no more than 2.5 percent of India's GDP is seen as sensible because there is little that can be done to lower the current account deficit if import prices are rising and exports are not increasing. The objective of the government is to develop policies that will boost exports while lowering unneeded imports, such as imports of gold.