India’s current account deficit came in at a mere 0.2% of gross domestic product (GDP) for the March 2015 quarter. For 2014-15 as a whole, the current account deficit was a low 1.3% of GDP. But is this reduction in deficit really a good thing?
From one point of view it is an unalloyed blessing, considering the free fall of the rupee during the taper tantrum, when India’s current account deficit was very high and when all currencies with high deficits were taken to the cleaners. But there’s more than one way of looking at the current account.
The usual method is to consider exports, imports and net income from abroad and arrive at the deficit or a surplus. But another way is to consider savings and investment in the economy—if domestic savings are higher than domestic investment, it will mean a current account surplus and if investment is higher than savings, that means a current account deficit.
Now take a look at the chart from the International Monetary Fund database, which shows India’s GDP growth, savings and investment and current account deficit every year from 2000 onwards and also the IMF’s projections till 2020. There has been a vast improvement in the current account deficit in recent years. But what was the reason for the high deficit earlier? Simply put, the investment rate was much higher then, as the chart shows. The investment rate went up much higher than the savings rate, resulting in a high current account deficit.