Rising Current Account Deficit

Rising Current Account Deficit

Subject: Economy

Section: External Sector

Context:

For the third quarter of 2021-22, India’s current account deficit (CAD) has reached $23 billion, which is a nine-year high.

Cause–

• Rise in import-India’s exports are doing well, but as imports are growing faster, widening of the trade deficit is likely in the near term- owing to global inflation and currency depreciation
• Capital outflows-
  • Foreign portfolio capital flows, which are a large component of foreign investment in India, have turned negative/ net sellers during the last 6 month. The imminent interest rate hike in the US is one possible, others being uncertain global growth prospects due to COVID and Ukraine War.
  • Private equity/Venture capital (PE/VC) funding slowing down

A combination of these unfavourable economic factors has led to a sharp decline in forex reserves.

Indicators of growing external vulnerability:

• Capital outflows
• Reducing forex and import cover
• Imported Inflation and related currency depreciation
• Rising current account deficit
• Forex composition- it is made up entirely of liabilities, namely the foreign capital inflows. This makes India’s forex reserves more vulnerable to the threat of a sudden exodus of foreign capital.

Foreign Direct Investment:

FDI is the process whereby residents of one country (the home country) acquire ownership of assets for the purpose of controlling the production, distribution and other activities of a firm in another country (the host country). FDI includes capital flows to listed and unlisted companies and private equity/venture capital (PE/VC) funding.

It is different from Foreign Portfolio Investment where the foreign entity merely buys stocks and bonds of a company. FPI does not provide the investor with control over the business.

Flows of FDI comprise capital provided (either directly or through other related enterprises) by a foreign direct investor to an enterprise. FDI has three components, viz., equity capital, reinvested earnings and intra-company loans.

• Equity capital is the foreign direct investor’s purchase of shares of an enterprise in a country other than its own.
• Reinvested earnings comprise the direct investors’ share (in proportion to direct equity participation) of earnings not distributed as dividends by affiliates, or earnings not remitted to the direct investor. Such retained profits by affiliates are reinvested.
• Intra-company loans or intra-company debt transactions refer to short- or long-term borrowing and lending of funds between direct investors (or enterprises) and affiliate enterprises.