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The Current Account Deficit Essay

3032 words - 12 pages

Macro Economics Project


Executive Summary

Balance of Payment
BoP, also known as balance of international payments, deals with an economy’s transactions with the rest of the world, for a specified time period. It involves goods, services and income, financial claims and liabilities and transfers such as gifts and foreign aid.
Balance of Payment involves two kinds of accounts –

Trade balance, or for India’s case, Trade Deficit, is a major component of Current Account Deficit. It the output in the economy can be characterised as Y, below equations can be derived as follows:

Y = C + I + G + NX
NX=Y– (C+ I + G )
NX = (Y– C– G ) – I
= S – I

Where,
C: Consumption; I: Investment; G: Government Spending; NX: Net Exports; S: Saving. As we can see from the above derivation, NX can also be expressed as the difference between saving and Investment.

Based on the above premise of rising current account deficit in the country, in this report we offer insights into the causes of CAD, identifying them as implicit or obvious causes, while also exploring some practical, situational and structural causes that account for worsening the current account balance in India. We map our analysis using IS model for open economy, use the data for trade balance, oil and gold prices for around past twenty years, from 1990-2013, to do a regression analysis that helps us comment on the correlation that might exist between the two statistics. We also explore J curve effect by analysing trends in currency exchange rate and trade balance for year 2013. Having established the causes of CAD, we explore the concept of twin deficit and its importance in the current account deficit discussion.

We then go on to listing some consequences of CAD, such as high inflation, loss of foreign reserves etc and list some innovative recommendations to reduce CAD sustainably and in the long-term. We then move on to a deeper discussion on the primary reason of CAD, i.e. high imports and focus on some of the major non-oil and non-gold imports that form a significant portion of India’s import bill. Towards the end we also explore some recent news items and trends in current account deficit and lay down a commentary on the same.

Table of Contents
1. The Current Account Deficit Crises …………………………………………. 4
2. The CAD crisis ………………………………………………………………. 5
3. Studying the cause of a high CAD with data analysis ……………………. 10
4. Twin Deficit ………………………………………………………………... 12
5. Consequences of Current Account Deficit …………………………………. 13
6. Innovative ways to reduce CAD …………………………………………… 16
7. Recent Trends in India’s Trade Balance and their impact on CAD ……….. 16
8. Insufficient savings and their impact on CAD …………………………….. 18
9. Trends as captured pictorially ……………………………………………... 18
10. Recent News and Happenings ……………………………………….…….. 20
11. References …………………………………………………………………. 21

The Current Account...

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