Case Study - Group 4

Dr. Mathew Joseph

Group 4 Puneet Arora (201111) Kriti Kashive (201067) Neharika Mallick (201086) Radha Mohan Giri (201113) Paras Dhawan (201101) Rakesh Kumar G.S. (201116)

What is the current account balance?

In economics, the current account is one of the two primary components of the balance of payments, the other being the capital account. The current account is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid). A current account surplus increases a country's net foreign assets by the corresponding amount, and a current account deficit does the reverse. Both government and private payments are included in the calculation. It is called the current account because goods and services are generally consumed in the current period. The balance of trade is the difference between a nation's exports of goods and services and its imports of goods and services, if all financial transfers, investments and other components are ignored. A Nation is said to have a trade deficit if it is importing more than it exports. The trade balance is typically the largest component of the current account; a current account surplus is usually associated with positive net exports. Net factor Income refers not only to the money received from investments made abroad (note: investments are recorded in the capital account but income from investments is recorded in the current account) but also to the money sent by individuals working abroad, known as remittances, to their families back home. If the income account is negative, the country is paying more than it is taking in interest, dividends, etc. India reported a current account deficit equivalent to 14.1 Billion USD in the second quarter of 2011. India is leading exporter of gems and jewellery, textiles, engineering goods, chemicals, leather manufactures and services. India is poor in oil resources and is currently heavily dependent on coal and foreign oil imports for its energy needs. Other imported products are: machinery, gems, fertilizers and chemicals. Main trading partners are European Union, The United States, China and UAE.

How is it influenced by fiscal deficit?

The economy has three domestic sectors: business, households, and government. Each has its own saving rate: business saving is the difference between cash flow and investment. Household saving is the difference between consumption (including spending on new homes) and family income (wages, stock dividends, Social Security checks, etc.) Government saving is the difference between expenditure and tax revenue. Any of these three sectors could either be running a surplus or a deficit. A budget deficit will produce a current account deficit if the business and household sectors dont save enough to finance that deficit. This is the situation the United States is in. On the other hand, Japanese households and business save so much that the country runs a current account surplus in spite of a gigantic budget deficit.

Gross Fiscal Deficit

450000 400000 350000 300000 250000 200000 150000 100000 50000 0

For example, we can have following cases: CASE 1: if household and business saving remains the same. an increase in the budget deficit will lead to an increase in the current account deficit (or a smaller current account surplus.) CASE 2: In a recession: Businesses and households usually slash spending and save more. But the drop in demand drives up unemployment which causes income tax revenue to fall and spending on things like unemployment insurance to rise. In this case, the recession may result in an increase in the budget deficit, but it may also result in an even larger increase in business and household saving, with the result that the current account deficit falls.

Examine this for India using data from the 1980s.

1982-83 1983-84 1984-85 1985-86 1986-87 1987-88 1988-89 1989-90 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

A Comparision
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1996-97

1981-82

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2009-10

-100000 -200000 -300000 -400000 -500000

Current Account Balance

Gross Fiscal Balance

Above we can see, in general, current account deficit of India increased as Fiscal Deficit increased and vice-versa. In the last three years, particularly, Current account deficit fluctuated in sync with Fiscal Deficit. India reported a current account deficit equivalent to 14.1 Billion USD in the second quarter of 2011. With the widening of merchandise trade deficit, India's current account deficit surged to 4.1% of GDP during this Q2 FY11 as against 3.2% of GDP in the previous quarter as imports grew at a higher pace compared to exports. A rise in the trade deficit, despite a sharper increase in exports than imports and an increase in net export of services, led to the widening of the current account deficit During Q2 FY11, while exports registered an average growth of 19.7%, growth in imports averaged at 30.9%. This widening of trade deficit can be attributed to the differential in the growth rate of India and other developed economy. A wider current account deficit would put pressure on the countrys ability to buy oil which is by far the largest component in Indias import bill. When India is selling dollars, it is losing the countrys forex reserves, which is not a very comfortable thought given that its a current account deficit country. Also It is estimated that India's fiscal deficit in the current fiscal year will exceed 4.6% of the gross domestic product target, though the final figures would depend on the actual expenditure. While it was "not impossible" that the fiscal deficit could swell to 5.5%, against the government's target of 4.6% for the year, Growing expenditure and less than anticipated growth will have implications for the fiscal deficit.

2010-11