India's current account deficit is at an unsustainable level, but we expect it to gradually decline in coming years, HSBC Research says
India's current account deficit (CAD), the equally ugly twin brother of the fiscal deficit, has widened significantly as savings have fallen more than investments. The deficit grew from an average of 0.3% of GDP (gross domestic product) in the five years preceding the global financial crisis (GFC) to 3.3% during the five years that followed. This has made India more susceptible to the vagaries of capital flows as we've seen in recent months, according to HSBC Global Research.
The wider deficit partly reflects the lower output in the US and Europe post-GFC, which slowed exports. Higher oil prices also played a role. But, the real problem has been at home. Macroeconomic policies were kept too loose, which combined with insufficient structural reform, widened supply-demand imbalances. Moreover, rising inflation led to a loss of competitiveness and higher gold imports.
The CAD is not sustainable because its high level and poor quality imply an increase in the external debt-to-GDP ratio if left unattended. Encouragingly, the trade deficit has narrowed in recent months, led by slower domestic demand, a weaker currency and policy steps to curb imports. These factors should help narrow the CAD this and next year.
However, policies have to be kept on track to further reduce the deficit, improve its quality and secure the necessary financing. The deficit and external debt profile are also sensitive to global financial conditions, which could tighten again when the US Fed eventually begins tapering. It is, therefore, important to keep macroeconomic policies tight and step up the implementation of structural reform to further reduce vulnerabilities ahead of Fed tapering and make the CAD sustainable over the medium term.
India's current account deficit (CAD), the equally ugly twin brother of the fiscal deficit, has widened significantly as savings have fallen more than investments. The deficit grew from an average of 0.3% of GDP (gross domestic product) in the five years preceding the global financial crisis (GFC) to 3.3% during the five years that followed. This has made India more susceptible to the vagaries of capital flows as we've seen in recent months, according to HSBC Global Research.
The wider deficit partly reflects the lower output in the US and Europe post-GFC, which slowed exports. Higher oil prices also played a role. But, the real problem has been at home. Macroeconomic policies were kept too loose, which combined with insufficient structural reform, widened supply-demand imbalances. Moreover, rising inflation led to a loss of competitiveness and higher gold imports.
The CAD is not sustainable because its high level and poor quality imply an increase in the external debt-to-GDP ratio if left unattended. Encouragingly, the trade deficit has narrowed in recent months, led by slower domestic demand, a weaker currency and policy steps to curb imports. These factors should help narrow the CAD this and next year.
However, policies have to be kept on track to further reduce the deficit, improve its quality and secure the necessary financing. The deficit and external debt profile are also sensitive to global financial conditions, which could tighten again when the US Fed eventually begins tapering. It is, therefore, important to keep macroeconomic policies tight and step up the implementation of structural reform to further reduce vulnerabilities ahead of Fed tapering and make the CAD sustainable over the medium term.
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