macroeco project final

7/29/2019 MacroEco Project Final

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Current Account Deficit : An Indian Perspective

Submitted by :

Group 5Aishwarya Kumar (PGP/16/063)

Anirban Bhar (PGP/16/064)Anusha Acharya (PGP/16/071)

Palak Bansal (PGP/16/097)Pratik Agrawal (PGP/16/101)

Nimish Shah (PGP/16/110)

Required as part of Term Project


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Current Account AnIntroduction

CAD An IndianPerspective

Case Study 1 USCAD and the Financial

Crisis

Case Study 2 Brazil :From Surplus to

Deficit

AGENDA


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Crisis


Deficit

AGENDA


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Crisis


Deficit

AGENDA


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Crisis


Deficit

AGENDA


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BOP: Balance of Payments

BOP

CapitalAccount

CurrentAccount

Current Account = TradeBalance + Factor Income+ Cash Transfer

Trade Balance : Exports

Imports

Factor Income :Earningson foreign investmentspayments made to foreigninvestors

Cash Transfers

Cash Transfer

Factor Income

Trade Balance

1

2

1

2

3


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Current Account : An Overview

CurrentAccount

Deficit Surplus

Nature of a Countrysforeign trade

Foreign AssetsForeign Assets

Positive Net Exports are generally accompanied by a Current Account Surplus However , in case of closed economy , the Factor Income may offset the Trade surplus and

might result in Current Account Deficit

Trade Balance

Factor Income


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Current Account : How is it calculated

CurrentAccount

Goods IncomeServicesCurrent

Transfers

Exports

Imports

Provided

Availed

Inflow

Outflow

Inflow

Outflow

Consists of Donations,Aids and OfficialAssistance

LEGEND : Credit Debit :


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The relation between CAD and Fiscal Deficit

CurrentAccount

PrivateSavings

Fiscal BalanceInvestment


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Is CAD always BAD?

ConsentingAdults

Transactionsconsideredfinanciallysound

Current Account Deficit

Excess ofImports

Excess ofInvestments

Low SavingsInter-temporal

Trade

Pitchford Thesis

Running aCAD today toachieve aCAS at a later

point in time

Indicateshighlyproductiveand growing

economy

ExcessiveConsumption

RecklessFiscal policy

IndicateCompetitivenessproblems

The Classic Answer : It Depends !!!!


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India : Current Scenario


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Indias CAD, at 3.9% of GDP Q1 2012 is approaching 1991 levels

Source :(1) Euromonitor International


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A persistent trade deficit has been the source of Indias CAD woes



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Trade deficit has been persistently negative, leading to CAD in India

Exports Imports

India has lost export competitivenessdue to a fall in manufacturingactivities

Traditional export items like textiles andreadymade garments, and leather andother manufactured goods have beengrowing at decreasing rates.

Regulations having reservations forsmall scale industries, reservations etc.

Harsh labour laws

Unfavourable indirect taxes

Poor infrastructure (road, logistics,storage, supply chain bottlenecks)

Delays in transportation (portcongestion, road transport)

16% pagrowth

21% pagrowth

Reasons for lacklustre export growth


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Rising fiscal deficit is also a contributor to CAD

PrivateSavings

(S-I)

PublicSavings

(T-G)

NetExports

(X-M)

India has been running a persistent fiscaldeficit leading to negative public savings,which hasnt been compensated by an

equivalent increase in private savings(which has remained flat at around 30%) ,leading to current account deficit

A high current account deficit means that acountry isnt able to sustain its day to dayexpenses from the revenue it earns

-12

-10

-8

-6

-4

-2

0

Budget balance (%

GDP)

Trade balance (%GDP)

CorrelationCoefficient = 0.52

Source :(1)Euromonitor International


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Gold and oil imports coupled with the depreciating Rupee is a major concern

22% rise in Gold and silver, cokes and briquettes and electronic goods imports from FY 2001- FY2010

Gold and silver combined were the 2nd most imported commodity in 2010-11. Whereas comparativelythe import share of other key industrial raw materials such as Coal, Coke, Iron and Steel is much lowerin the total import bill of the country.

Global economic uncertainty has led to gold being considered as a safe haven asset

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

0

5000

10000

15000

20000

25000

30000

35000

40000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Gold Imports (US$ Mn)

Current Account Balance (% GDP)



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Unfavorable exchange rate movements with increasing oil prices raised imports

Share of crude oil imports increased from 23% in FY 1995 to 31% of the import bill in FY 2010

The middle East crisis and US tensions with Iran (Irans threats to shut down the Strait of Hormuz) were

responsible for high oil prices. Speculation over the commodity market could also be a cause of oil priceincrease

However, lower overall global demand, specially because of the Euro crisis, is expected to lead to easing ofoil prices

-35.0

-30.0

-25.0

-20.0

-15.0

-10.0-5.0

0.0

5.0

10.0

15.0

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

Petroleum/Crude imports (US$ Mn)

Current Account Balance (% GDP)

% Change in currency (Rs/$)



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Aggregate demand (C+I) exceeds Domestic Output (Y) - Compared to its Asianpeers, India remains a low export, high import (consumption) economy

Indias growth is mainly consumption driven and not manufacturing driven (export driven). As a result, despite the globaleconomic turmoil, Indias growth wont be affected. The downside to this is that this consumption is dependent on variables such asexchange rate. An appreciation of the Indian currency due to foreign capital inflows would boost imports, and henceconsumption, but a depreciation of the rupee would adversely affect consumption.

Source :(1)Kotak Mahindra Research


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How does Indias CAD sustain itself?


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Deficits in Indias CAD are made up for by surpluses in its Capital Account

Over the last three years,

Indias CAD has deterioratedsteadily owing to the globalfinancial crisis, Euro crisisand weak global economy.

Capital flows may beunsustainable and volatile in

the long run, as suddenoutflows may destabilize the

economy



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Indias exchange rate fluctuates in tandem with portfolio flows

Excess appreciationof the currency due

to capital inflowsdiscourages exports

and increasesimports, leading todeindustrialization

and loss of

employment



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IT services and foreign remittances help prop the current account deficit

India received foreign remittances of US$ 54 Bn in 2010, making it the largest receiver ofremittances in the world

The IT industry has played a

major role in propping up thecurrent account, specially

during the 2008 financial crisis.The industry has been bringing

in foreign exchange throughthe export of its services and its

employees across the worldhave contributed to the

remittance pool. Remittances

remained stable at US$ 46 bn in2009, whereas capital accountsaw huge swings



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Is Indias CAD sustainable for long term growth?


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Economists and former RBI Governors opine that the sustainable level ofCAD is around 2.5%

The current CAD levels are not too high for India to cut imports drastically and provide highlevels of export subsidies. These levels, though high, can be taken care of by effective policymeasures.

A strong self-correcting mechanism is at work. The big CAD has caused the rupee to fallsharply, from Rs 45 to Rs 56 to the dollar. As a result, the rupee has weakened to a verycompetitive level, which by itself should trim the CAD.

Despite policy paralysis and a poor investment climate, India received large inflows of bothFDI and foreign portfolio inflows in 2012. Despite bad publicity from the alleged mistreatmentof Vodafone and Walmart, FDI inflows actually shot up 34.4% to $46.84 billion in 2011-12. FIIinflows are typically far more volatile than FDI. However, despite the Eurozone crisis andrecent slowdown in the US, FII inflows into India exceeded $10 billion in January-July 2012.

Growth-inducing policy measures would lead to increased confidence in the economy thatwould bring in more capital inflows. Also, with the INR deemed to have reached the true

levels that reflect the state of Indias economy, further depreciation seems unlikely and with

the advent of J-curve effect, Indias CAD would become more favourable over a period oftime.


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Our Recommendations


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Increase innumber of SEZs

Recommendations to improve CAD

Build strongmanufacturing

base, boostexports

Currently India has surplus workers in agricultural sector. If manufacturing

sector gets a boost, these surplus workers could get employment

Diversification of current export basket in terms of location (reducedependency on Eurozone) as well as products

Indian exports need to move up value chain at global level

Encourage

FDI/FII inflows

Recent government policies like FDI in retail and aviation encourage capitalflows and capital account surplus, which can cushion CAD

. Local land restrictions, labour, political and environmental restrictions are in astate of flux, and these uncertainties make it more difficult for foreign investors toinvest in India.

Tax sops for manufacturing specially small scale industries. Encourageforeign investment in roads, infrastructure, logistics and supply chain.

SEZs have made exporting easier and hence export growth from SEZs hasbeen phenomenal (121% y-o-y growth 2009-2010)


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Improveproductivity /

structural reforms

There should be reforms to improve governance and reduce wastage ingovernment programmes

Encourage private enterprise and innovation. All such measures will improveproductivity. A number of projects are stuck in bureaucratic mire environmentalregulations, labour laws, unfavourable tax policies etc.

Replicate Brazilmodel

Export growth through growth in agricultural products - India has the largestarable land in the world and is one of the largest producers of agriculturalcommodities and grains. However, net exports have remained small and the

variety hasnt changed over the years

. India could increase its agricultural exports through drastic measures like theGreen Revolution of the 1970s.



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Reduce golddemand

Reduction in demand of gold through education of investors of alternativesources of investment

Increase domestic production of gold to reduce dependency on imports

Discover/developalternate energy

sources

Encourage through policies and investments in development of alternativesources of energy like Shale gas

Following model of Gujarat of boosting investments in solar panels would go along way in reducing Indias oil imports over a long period of time.

Use Monetarypolicy

Offset unfavourable exchange rates. E.g. use open market operations toincrease/decrease liquidity and interest rates to regulate capital flows in/outsidethe country



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Case Study 1 : US Current Account Deficit and2008 Financial Crisis


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2008 Financial Crisis : What went wrong

Current Account Deficit

Net Savors to NetDebtors

Large Treasury Debtissued

US considered a safehaven

High Oil Prices

Oil exporting countrieshaving huge income

Invested in US

As investmentsincreased Yield

decreased

Investors moved toriskier assets

Mortgage backedseurities


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United States of America : CAD and 2008 Financial Crisis

CurrentAccountBalance(In$billion)

Source :(1) World Bank Statistics(2) World Economic Outlook

This line denotesInvestment (as apercentage of GDP)


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United States of America : Housing Price Index(1)

Source :(1) http://www.frbsf.org/publications/economics/letter/2011/el2011-37.html


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Case Study 2 : Brazil Current Account Surplusto Current Account Deficit


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2004-2007Current Account

Surplus

Surplus turns to Deficit

2008Sub-pri

meCrisis

Developing EconomyGrowing Demand

Increasing Deficit

High Import demandLow Exports*

Heavy dependence onExternal funding

HighInflation

Debt TrapWeak

Currency

* - Due to weak Global demand,the exports were falling

Might lead to

Although the Surplus waslow, but it is a good signfor a Developing country

Brazil : The falling BRICK?


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Brazil : Current Account Surplus to CAD

CurrentAccountB

alance(In$billion)

Source :(1) World Bank Statistics


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In the long run we are all

dead- John Maynard Keynes

..so enjoy life while you still can

macroeco project final

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