India’s economy can cope with a current account deficit (CAD) of 2.5-3.0% without facing an external sector crisis, Reserve Bank of India (RBI) Deputy Governor Michael D. Patra said on Saturday.
“Our experience has been that India can sustain a current account deficit of 2.5-3.0% without getting into an external sector crisis,” Mr. Patra said in a speech on Saturday.
Considering the increase in international crude oil prices in 2022, the trade deficit has widened causing concern. In July, the trade deficit widened to a record $30 billion due to a 70% surge in crude oil imports.
Explaining the context for the significance of the current account deficit, Mr. Patra said: “The current account deficit (CAD) in the country’s balance of payments (BoP) determines how much of foreign savings or net capital inflows into the country can be absorbed or used for growth. Exports earn foreign exchange while imports have to be paid for in foreign exchange”.
He said given India’s reliance on the overseas purchase of items that the country does not produce such as crude oil and items such as machinery, equipment and technology, imports typically exceed exports and hence earnings of foreign exchange were not sufficient for covering import payments. “The gap has to be filled by borrowing from abroad which, however, has to be serviced through principal and interest payments,” he said, adding “if debt servicing exceeds our earnings, we have to either reduce imports and stifle our growth prospects or default on debt payments and face international isolation”.
Recounting how a record increase in oil prices and high gold imports had pushed the current account deficit above the “Plimsoll line [of 2.5-3% of GDP levels] and to historically high levels during 2011-13” Mr. Patra said the U.S. Federal Reserve’s contemplation of an end to easy monetary policy in the summer of 2013 and the consequent ‘taper tantrum’ had led India to being labelled as a part of the ‘fragile five’ economies comprising Brazil, India, Indonesia, South Africa, and Turkey.
Mapping India’s growth over the decades, he said a striking feature of the economy was that the growth had been home financed. “Investment is financed primarily by domestic savings, with foreign savings playing only a supplemental role.”
“Another noteworthy feature is that the saving rate has started slowing down since 2007-08 after the global financial crisis. Eventually, this pulled down the investment rate which has exhibited deceleration since 2012-13. Reversing this trend is critical to achieve higher growth,” he stressed.