Rising Challenges: India’s Widening Current Account Deficit and the Road Ahead

India’s current account deficit (CAD) for the first quarter of FY2024 has widened to $9.2 billion, a significant increase from $1.3 billion in the previous quarter (January-March 2023), according to the RBI.

Several factors contribute to this increase in the deficit, in particular a pronounced trade imbalance, the reduction in the net services surplus and the decline in private transfer receipts.

The trade deficit has widened notably due to a sharp reduction in India’s merchandise exports due to sluggish demand from Western nations and China. Although services exports have grown by 22.8% in January-March, concerns have been raised about future global demand for software and banking services.

Historically, India has been a net importer, mainly due to considerable energy imports. In addition, gold imports have soared 38.75% to $4.93 billion in August, due to demand at festivals and the wedding season.

Despite the current challenges, the trade balance improves quarter by quarter thanks to the reduction in the trade deficit of -9.21 billion dollars, compared to -17.96 billion the previous year (table 1). The decline in global raw material prices this year has played a crucial role in this positive development.

One of India’s main challenges is the rise in oil prices, exacerbated by the decision of the OPEC+ group to cut crude oil supplies until December, coinciding with the winter season of high demand. India’s crude oil import basket reached a staggering $93 in September supplies. The price of Brent crude oil soared to a yearly high of $100 a barrel, further stoking concerns.

The consequences for the import-dependent Indian economy are inflation. Rising energy costs impact transportation costs, which in turn raise the prices of essential goods and services. This inflationary pressure affects the average Indian citizen, putting pressure on family budgets. Furthermore, they have contributed to the increase in the trade and current account deficit, which is now a harsh reality.

India’s current account deficit (CAD) in the first quarter of FY2024 has widened to $9.2 billion, a significant increase from $1.3 billion in the previous quarter (January-March 2023), according to the RBI . Several factors contribute to this widening of the deficit, in particular a pronounced trade imbalance, the reduction in the net services surplus and the decline in private transfer receipts.

The trade deficit has widened notably due to a sharp reduction in India’s merchandise exports due to sluggish demand from Western nations and China. Although services exports have grown by 22.8% in January-March, concerns have been raised about future global demand for software and banking services.

Historically, India has been a net importer, mainly due to considerable energy imports. In addition, gold imports have soared 38.75% to $4.93 billion in August, due to demand at festivals and the wedding season.

Despite the current challenges, the CAD is improving quarter on quarter due to a reduced trade deficit of -$9.21 billion compared to -17.96 billion the previous year (Table 1). The decline in global raw material prices this year has played a crucial role in this positive development.

India’s current account deficit (CAD) in Q1 FY2024 has widened to $9.2 billion

One of India’s main challenges is the rise in oil prices, exacerbated by the decision of the OPEC+ group to cut crude oil supplies until December, coinciding with the winter season of high demand. India’s crude oil import basket reached a staggering $93 in September supplies. The price of Brent crude oil soared to a yearly high of $100 a barrel, further stoking concerns.

Indian Prime Minister Narendra Modi speaks with his Israeli counterpart

The consequences for the import-dependent Indian economy are inflation. Rising energy costs impact transportation costs, which in turn raise the prices of essential goods and services. This inflationary pressure affects the average Indian citizen, putting pressure on family budgets. Furthermore, they have contributed to the increase in the trade and current account deficit, which is now a harsh reality.

As India grapples with import-related challenges, it is not immune to export difficulties. India has imposed export restrictions, especially on agricultural products, which have led to lower export realization. As if that were not enough, India’s agricultural import bill is rising, mainly due to increasing imports of edible oil and pulses. The possible import of wheat from Russia could further affect our foreign exchange reserves and put pressure on the rupee. On the other hand, weak demand in international markets for labour-intensive Indian manufactured products such as gemstones and jewellery, textiles and garments, marine products, handicrafts, handlooms and leather products, results in lower foreign exchange inflow.

Supply chain disruptions have compounded India’s economic woes, causing an unprecedented rise in the cost of imports of essential goods such as fuel, food, fertilizers, coal and essential minerals. The increase in imports of edible oil and pulses is due to low domestic production and disruptions to the global supply chain caused by alternative uses of edible oil as biofuel, the conflict between Russia and Ukraine and the deterioration of diplomatic relations with Canada.

High interest rates in major economies, economic downturns and faltering consumer confidence in countries like China and the United States have reduced demand for India’s merchandise exports. The Indian gemstones and jewelery sector has stopped the import of rough diamonds for cutting and polishing due to weak demand from major markets such as the US, China and the EU. Indian textile exports face price competition from Bangladesh and Vietnam, and pharmaceutical exports are affected by increased regulatory compliance.

Uncertainty in global financial markets has further complicated India’s economic challenges.

The possibility of a US government shutdown, rising bond yields and foreign capital flight to the US amid rising interest rates from the Federal Reserve have created a complex economic outlook for India.

With a rising CAD, it is crucial for India to prioritize boosting exports, especially merchandise. DAC in India is usually the result of a trade deficit, where imports exceed exports. By focusing on increasing merchandise exports, especially from areas where it has supply capabilities, i.e. textiles, leather, pharmaceuticals, processed foods, marine products, handicrafts and handlooms, etc., India can work towards reduce this trade gap, which is a significant contributor to DAC.

India has imposed export restrictions, especially on agricultural products, which have led to lower export realization

Furthermore, merchandise exports not only generate foreign exchange earnings but also help improve production and employment opportunities. Consequently, we should focus on diversifying export destinations to reduce dependence on specific regions or countries such as the EU, North America and China. This can make India’s exports more resilient to global economic fluctuations.

The Indian economy is navigating a maze of interconnected challenges such as rising oil prices, export restrictions, global economic uncertainty and supply chain disruptions. These factors have led to a decline in exports, an increase in the import bill, tensions in the current account balance and pressures on the Indian rupee. Addressing these challenges requires a multifaceted approach, encompassing domestic policy reforms, diversifying export markets and improving economic resilience to global shocks. India’s ability to overcome these obstacles will be critical to ensuring continued economic growth and stability in an ever-evolving global landscape.

Article republished from The Wire within the framework of an agreement between both parties to share content. Link to original article:

Professor at IIFT, New Delhi