ME Presentation_Group No 2

8/12/2019 ME Presentation_Group No 2

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CurrentAccount Deficit

By Group No 2

Akshay JayaprakasanAnirudh S.Anuradha DhoteAparna Goswami

Apurba Roy ChowdhuryAseem Agrawal


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Current account deficit the larger picture

Balance ofpayment

Capitalaccount

Currentaccount

Capital account

Reflects net change inownership of nationalassets

Includes FDI, Portfolioinvestment, Otherinvestment, Reserveaccount

Current account

Balance of trade Factor income(interest

and dividends frominternational loan andinvestments

Net transferpayments(e.g. Foreignaid)

BoP is a statement that summarizeeconomys transactions with the rest oworld for a specified time period. balance of payments, also known as ba

of international payments, encompassetransactions between a countrys residand its non- residents involving goservices and income; financial claims onliabilities to the rest of the world; transfers such as gifts.


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Components of CADA major component of CAD consists of trade deficit

Y= C+ I+ G+ NX

NX = Y (C + I + G )

NX = (Y C G ) I

= S I

trade balance = net capital outflows

NX = Exports - Imports

NX = Saving - Investment


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CAD trends

CAD balance (Quarter-wise)

CAD as % of GDP (Quarter-wise)


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CAD crisis

Why is there a crisis?

Hence, CAD, along with a high trade deficit puts pressure on the currency thread to growth macroeconomic stability

Of late, with restrictions on gold imports and strong measures to address depreciation, CAD is expected to improve dramatically. However, this comballooned to 4.8% of the GDP or, $88 billion, in the year 2012-13

Hence, we need to understand CAD, its associated causes and consequencan be sustained at moderate and predetermined level in the long run


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Causes of a high CAD Changes in exchange rates: As the exchange rate determines a countrys foreign t

Assuming demand for exports is relatively elastic then a depreciation will lead to an increand therefore improve the current account deficit. However, in practice this may not demand, profit margins and global demand. Depreciated currency also attracts less fore

decrease in capital investment

Changes in income: When people can afford to buy more goods, increased consumption may

Less competitiveness: The economy becomes less competitive leading to decrease in expor

Recession in other countries: Major trading countries such as US & EU have experienreduction in import of our goods adding to CAD.

Debt: To finance deficit and current account the government has incurred high debt while CA

High Imports: Due to rising prices in gold and oil imports with very little decrease in demahas remained high which is a cause of concern

Government spending: Increase in government spending leads to twin deficit, both fiscal an


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Economic models

Mapping tradedeficit acomponent ofCAD - on the IS

model


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Economic models

Exploring

increase ingovernmentspending -leading to fiscaldeficit and tradedeficit


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The Marshall-Lernercondition

Condition under which a realdepreciation (a decrease in )leads to an increase in netexports.

The depreciation leads to a

shift in demand, both foreign

and domestic, toward

domestic goods. This shift in

demand leads in turn to both

an increase in domestic

output and an improvement

in the trade balance. The

magnitude is more in this

case than the increase inforeign demand.


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Statistical Models

India is a hugconstituting aof imports.

It significantlytrade deficit.

Hence, correloil prices andpositive as cathe scatter plo


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Statistical Models

Indians invesgold assets.

Until the receimport , it consignificant powidening CAD

Hence, positivbetween goldtrade deficit cthe scatter plo


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Causes of a high CAD

Taking a new perspective structural causes

Measures like curbing gold imports to reduceCAD are only short-term and temporary, andbound to have undesirable side effects, for e.g.Increase in smuggling.

Imports looking away from gold and oil

India has the third largest coal reserves in theworld, and yet imported 135 million tonnes in2012-13.

No domestic production capacity has been createdin the fertilizer sector for some two decades. This isdespite the fact that import sector is given a hugesubsidy


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Causes of high CAD

Taking a new perspective structural causes

Unsustainable measures to reduce CAD

To address high CAD and its consequences like , currency depreciation, the government tmeasure to attract dollar inflows in the country, often by means to incentivising corporatincrease External Commercial Borrowing. As more capital flows in, it increases debt buand shifts macroeconomic focus from trading to non-trading activities, thus further increaCAD

External reserves build-up as a result of capital inflows, which is also used to finance the Crings an unhealthy trend in the economy


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Twin Deficit

Budget Deficit Trade D


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Government Spending

Interest rate Consumption

Capital Account Current Account

Surplus Deficit


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Changes in the Economy


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Consequences of Current Account Defi


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LOSS OF FOREIGN RESERVES

We loose reserves in the form of payments for the goservices being imported and also the money borrow

the foreigners needs to be repaid and that leads to loforeign reserves in addition to that.


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IMPACT ON EXCHANGE RATE

Due to increase in the exchange rate Foreign capital starts floeconomy which would increase the demand of domestic currCurrency Appreciation

But if the inflow of funds is not enough to fund the deficit, the

currency of the economy starts to DEPRICIATE with the concthe country will not be able to fund its current purchases.


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DEPENDENCE IN FOREIGN INDUSTRIES

So if the foreign industries take a hit that also has an impact odomestic eonomy


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Extent of CAD

It depends on how much capital flows a countattract. So when a country needs money to finCurrent Account Deficit it tries to make the ecan attractive destination for foreign investors


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Sustainability of CAD

The current account deficit is funded by inflow of foreign fundeconomy

INFLOWOF

CAPITAL

CAPITALINVESTMEN

T

CAPITALFLOW


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Capital flows Can be either long term or short term Eg. FIIs vulnerability in the economy as it puts an upward pressure oninterest rates to attract capital flows

Capital Investment Long term investments

Eg. FDIs


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Iceland Crisis

Iceland is an example of a country with a large current deficitlater imploded. In the years leading up to 2008, there was a shof capital to Icelandic banks. This enabled Iceland to run a reccurrent account deficit. Iceland was spending more than theyearning. When capital flows dried up, banks lost money and trapid deterioration in the current account.


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CAD Good or Bad?

GOOD BAD

CAD is sustainable and thus good,if it is being funded by long terminvestments rather than short terminvestments

But selling long term assets to funshort term consumption,undermines future production andin that CAD is bad

Also if the CAD exits to meet the

curent consumption needs, insteaof long term investments then itsbad


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Reason why CAD should be funded by long teris that short term funds or HOT MONEYcausevulnerability in the economy and if suddenly tare pulled out it causes a LIQUIDITY CRISIS ineconomy.


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Innovative ways to reduce CAD

Increase country-specific bilateral trade, for e.g. with China in view of increas

wages and their new economic policy to move away from export-led growth

A long-term solution to the problem cannot be one of borrowing more (througuaranteed foreign debt incurred by public sector companies for example) orforeign investors and attracting more foreign capital.

A sharp reduction in gold imports is what the Government needs to aim for. Aexperience is any guide, raising duties on gold imports does not seem to help it seems to increase imports by those speculating that duties would rise even Stringent quantitative restrictions on the volume of permitted gold imports a

Quantitative restrictions on those imports that are not only non-essential, busubstitution could help the economy to regain crucial production capacity andelements of manufacturing potential.

Diversification of the export basket and the destinations they go it, improvemdomestic supply conditions, and overall global demand conditions are more rboosters than depreciation.


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Discussions

Part 1Flashback of CAD


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1991 Economic crisis

What lead to the crisis?

Large and growing fiscal imbalances over 1980s

Spill over effect on trade deficit

External payments crisis


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Discussions

Part 2What causes CAD ??

1 QUALITY OF IMPORTS


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1.QUALITY OF IMPORTS

An economy that is growing at a faster rate than other nations haand usually runs a current account deficit.

If a country imports more capital goods, it means there is an ieconomic activity. Companies import capital goods equipment oexpand capacities.

However, Indiasimports primarily include oil and gold. These twodo not help any manufacturing and export growth.

Indias oil imports rose despite an overall economic slowdowcontinued to import gold as demand stayed high. This was despiteduties imposed on import of gold.

Recently another worrying factor has been the sharp rise in coasteep fall in iron-ore exports


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OIL IMPORT IMPACT

Indias oil bill continues toremain a major import itemowing to inelastic and growingenergy demand and risingglobal crude oil prices due toexogenous factors such as themiddle eastern geopolitical

situation and the Arab Springepisodes.

Studies have shown that eachUS $ 10 per barrel change in theoil prices affects Indias CAB byUS $ 8 billion ( center for budgetand governance accountability)


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GOLD IMPORT IMPACT

India accounts for 25% of the worlds gold demand. Share increasebn (2009-10) to US$ 57 bn (2011-12)

Share of gold imports has increased from 7.6 % (2005-06) to 12.6%

Major reason believed to be global hike in gold prices post the sub-gold seen as a safe haven

Demand spurt due to investment dynamics rather than historic affijewelry.

Further encouragement by Gold loan schemes granted by banking financial companies (gold loans worth Rs. 150000 Cr in 2012 as agin 2008)

Additional benefits of saving in gold.

Rising gold demand due to various factorh d h CAD b i


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g ghas caused the CAD to worsen by causingvery large trade deficit.

RISING COAL IMPORTS


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RISING COAL IMPORTS Though the second largest producer of coal in the world,

Indias coal imports have seen a steady rise from 20 milliontones in 2001 to 130 million tones in 2012, causing a sharpUS$ 18 billion rise in the import bill.

With 60-70% of the countrys electricity demand beingcatered by coal alone, further rise in future expected unlesslarge scale alternate energy source implementation isntdone.

DISAPPEARING IRON ORE EXPORTS


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DISAPPEARING IRON ORE EXPORTS

Sharp fall in export of iron-ore from 117 mt in 2009-10 to 18min 2011-12, India is now expected to become a net importer ithe current fiscal decade; adverse impact on CAD.


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INSUFFICIENT SAVINGS

S-I =CAB

CAD implies that the savings available in the economy are nto satisfy the investment made and this can be made up capital (in the form of financial aids, stimulus packs, borroabroad).

Insufficient savings in the private sector- low income levelsor high price levels

Insufficient government savings- higher expenditure on devprojects , welfare schemes, subsidy etc which do little tproduction/output.


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OTHER FACTORS

uncompetitive exports

1) due to fixed exchange rates

2) due to inflation

Falling inward remittances Restrictive legislations and policies

Recession in other countries, especially the trading partners


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Discussions

Part 3How to reduce CAD?


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Import controls

A country can levy tariffs onimports

This will lead to increase in price ofimport goods.

So the demand for imports should

fall . This will be good for domesticproducers as well as helping thecurrent account deficit to fall.


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Why it might not work ?

The foreign firm can

absorb tariffs andbalance out priceincrease not a longterm option

WTO intervention- iftrade and tariffagreement violatedWTO will intervene tosort out differences.

d l f h h


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A devaluation of the exchange rate

This involves reducing the value of the currency against

others.

The price of importing goods increases and the

quantity demanded of imports falls. Exports will be become cheaper and there will be an

increase in the quantity of exports

assuming demand is relatively price elastic, we wouldexpect a devaluation to lead to an improvement in the

current account


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Why it might not work ?

The resulting higher import prices lead to higherinflation

Devaluation is the easy way out for exporters but is apoor long term option.

governments avoid devaluation at all costs, even thoughit makes industry more competitive


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Supply Side Policies

Improve the competitiveness of the economy andhelp make exports more attractive.

Benefits of Supply Side Policies

Lower Inflation Lower Unemployment

Improved economic growth

Improved trade and Balance of Payments.


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Various Supply side policies

1. Improving Transport and infrastructure

2. Deregulation of economy

3.Reducing Income Taxes.

4. Increased education and training

5. Deregulate financial markets6.. Privatisation


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Deflation

If a government reduces aggregate demand by raising interest rincreasing taxes then people will have less money to spend so tconsumption of imports.

High marginal propensity to import so a reduction in AD impcurrent account significantly

Deflationary policies will also put pressure on manufacturerscosts and this will lead to more competitive exports and so exincrease


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Discussions

Part 4Recent News and Happenings !

India's current account deficit falls to $5.2 bJuly-September quarter


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July-September quarter

Narrowed sharply to USD 5.2 billion

in the July-September quarter of2013-14

1.2% of GDP

Decline in gold imports

Was USD 21 billion, or 5 per cent ofthe GDP, in the second quarter of lastfiscal.

Expected CAD to be below USD 56billion in the current fiscal comparedto the record high of USD 88.2 billion,or 4.8 per cent of the GDP last fiscal

http://timesofindia.indiatimes.com/business/india-business/Indias-current-account-deficit-falls-to-5-2-billion-in-July-Sept

Rupee to be fairly stable with CAD narr


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Rupee tobe fairly stable with CAD narr

From the macro viewpoint, the growthtrajectory seems to be fairly stable andquite positive

From the viewpoint of the US being aconsumer of exports from many othercountries, it is fairly reassuring at thispoint

Negative aspects of the US macroenvironment are the risks associatedwith a lack of reconciliation, both on thebudget and on the debt ceiling

Rupee depreciation is helping exportsgrow and imports are contained

http://economictimes.indiatimes.com/opinion/interviews/rupee-to-be-fairly-stable-with-cad-narrowing-subir-gokarn/a

A fall in CAD does not mean a fall in gol


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A fall in CAD does not mean a fall in goldemand

India produces almost no g

Gold smuggling is a fairly luoperation

Mumbai airport customs haaround 73kg gold worth Rsbetween April and October

Unofficial gold will continuway into the country to sati

http://www.firstpost.com/economy/a-fall-in-cad-does-not-mean-a-fall-in-gold-demand-1263991.html

ME Presentation_Group No 2

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