Is a large current account deficit sustainable?

Is current account deficit a bad economic signal?

A country faces a trade deficit when its imports exceed its exports. As long as foreign investors are willing to finance this difference by net capital flows into the country, the situation poses no economic problem. The depreciation pressures from current account are balanced by appreciation pressures from financial account. A current account deficit is sometimes caused by economic growth – faster growth – more imports than exports. Higher economic growth also gives attractive returns to invested capital and attracts foreign investment. These capital flows provide natural financing for current account deficit. 

Is a large current account deficit sustainable?

Normally in a developing economy a deficit ranging from 2-8% of GDP is observed. At the higher end – it’s a concern particularly when the foreign investment comes from debt investments rather than foreign private investors. In India the Current Account Deficit is hovering around 4-4.5% of GDP. 

A large current account deficit is sustainable if non residents are willing to finance it continuously. As soon as foreign investors reduce their financial flows, or seek to repatriate their invested capital, the financing of the current account deficit will disappear and adjustments will need to take place, usually in the form of the currency depreciation. Recall also that income payments are part of current account, so too large a foreign debt burden can exacerbate current account deficits.

Currently the Current Account Deficit in India is around the danger mark and that explains the government’s urgency in taking steps that send positive signal to foreign investors and the capital inflows improve. Mamta and company please pay heed – the situation is not that comfortable.