The CAD is a lot more worrisome than the trade deficit
During the week the trade data was announced wherein the trade deficit came in sharply lower at $12 billion. This is in comparison to $16 billion reported in the month of January. Even the growth in exports of goods was sharper than the previous months while the growth in imports were slower. But the real worry was not on the trade deficit front. The real worry was on the current account deficit front. Here is why the CAD really matters
Why CAD matters
There is a very important distinction between the trade deficit and the current account deficit. While the trade deficit only captures the deficit on the merchandise goods, the CAD captures the visible and the invisibles. For a long time, India has run a deficit on the merchandise trade account but it has run a surplus on the services trade account. That is because revenues from the $100 billion software sector were a big contributor to the services exports figure. That largely compensated for the deficit on the merchandise trade account. However, for the Oct-Dec 2017 quarter, the current account deficit has widened to $13.5 billion. This is sharply higher than the CAD of $8 billion in the previous year. Even in percentage terms, the CAD for the quarter stands at (2%) of GDP as against a level of just (1.4%) in the previous year. Why this is a matter of worry for the economy and what are the likely implications?
Trade deficit is widening
There are two aspects to this current account deficit story. Firstly, the merchandise trade account has been consistently worsening due to rising imports. For example, the total imports are likely to touch $450 billion for the fiscal year 2017-18 and that is assuming that crude oil prices remain around these levels. If oil prices go up then the import bill could burgeon. Secondly, this figure needs to be seen in terms of the import cover provided by the forex reserves. For example, the current reserve position of $425 billion is just about sufficient to cover 11 months of imports. This could worsen in the coming year when the total imports are expected to exceed $500 billion.
Bigger worry is on services
Service sector is a worry because the IT sector is struggling to grow on the back of weak tech spending the world over. That means the service surplus will continue to lag putting further pressure on the CAD. As we have seen on previous occasions, a CAD of above 2% makes the INR vulnerable to sustained selling by forex traders. Even importers could rush for cover and FIIs could start selling which could worsen the currency situation. The CAD has gone up sharply from 1.4% to 2% in a year. This is something the RBI needs to really worry about. Else the INR and sovereign ratings can come under question! ©