Explained: India’s Current Account Surplus

Current Account Surplus Explained

In the past few years, the Indian consumer has witnessed an increase in their shopping options. Uber-popular western retail brands such as Bath and Bodyworks and the Swedish furniture tycoon Ikea have paved their way into Indian shopping carts. Furthermore, brands such as Uniqlo and the lingerie expert Victoria’s Secrets plan to set up more stores in the country, giving Indians access to all those products that were the staple souvenirs from those returning from abroad. Whilst these labels will end up appeasing the Indian consumer, will they weaken the current account (CA)?

What is the Current Account Balance?

The current account balance of a country is a record of a country’s transactions with the rest of the world. It measures the value of the goods and services exchanged, payments made and received, and remittances. This is yet another economic indicator that is measured as a percentage of the Gross Domestic Product (GDP). Recently, the Reserve Bank of India (RBI) released the current account statistics for the second quarter of the FY 2020-21. India’s current account balance stands at USD 15.5 billion which amounts to 2.4 percent of the GDP, which is the highest for India since 1975.  The net income from services contributed largely to the current account surplus. However, there still exists a  merchandise trade deficit to the tune of USD 14.8 billion. The merchandise trade deficit implies that the value of the country’s imports of goods is higher than the value of the goods it exports. 

The current account, the capital account, and the financial account together make up the Balance of Payments (BoP). The BoP is affected by various aspects of the global as well as the national economy. The interest rate, the exchange rate, the stock market, and trade policies all have an impact on a country’s BoP. Additionally, BoP also forms the basis for major political and diplomatic strategies.

The Indian Current Account Balance and Covid-19?

While the Coronavirus pandemic has dampened everything that came in its way, it may have helped India’s current account balance. The IT services industry has seen a huge boom, IT darlings – Infosys, Tata Consultancy Services (TCS) & Wipro have seen a tremendous increase in demand for their services. The pandemic has forced businesses to go digital, even the traditional ones are now looking at the Internet of Things (IoT) for solutions to their woes. This means more demand for internet services such as digital payments, cybersecurity, and cloud services. For instance, when we consider the pre-pandemic times for the same period (July-September) in 2019 the Indian current account was negative USD 7.6 billion.

On the flip side, the pandemic has deteriorated the merchandise trade. The demand for Indian exports has been affected by the various restrictions that were introduced by the country’s major trade partners such as – The United States, The United Kingdom, and China. Further, the pandemic has caused a logistical nightmare for the transport of goods. 

Surplus, has a positive ring to it, however, does the current account surplus necessarily mean a good thing?

To grasp this better, we should look at the current account in two parts – the first being the merchandise trade (goods) and the rest of the components of CA. The deficit of merchandise trade does not necessarily mean a bad thing, showing strong demand for imports. Steady demand for imports implies that the economy is in a good condition – industries are growing, consumer spending is on the rise.

The second quarter of 2020 saw an increase in the trade deficit from USD 10.8 billion to USD 14.8 billion. This increase in the trade deficit is a good sign, pointing towards a recovering economy. As per the definition of the BoP, its net should be equal to zero, which is to say that if the current account is positive (surplus) then the capital account has to be a negative (deficit). The capital account is that part of the balance of payments that records the financial flows transactions. A deficit of this account implies that the country has experienced more outflow of financial funds.

In the second quarter of FY 2020-21, India has experienced a capital account deficit of USD 16.2 billion. The capital account deficit points to the fact that more funds are moving abroad as compared to the funds coming in; making India a net lender to the rest of the world. India has invested more funds abroad than domestically. In the larger scheme of things, an increase in foreign investments by India would reduce rupee demand and weaken the rupee vis-à-vis the dollar. A weaker rupee would make Indian exports cheaper pointing to increased competitiveness, which would then help boost Indian exports. On the contrary, would make it more expensive for India to import goods. 

One of the critical determinants of the BoP in the coming future is going to be Atmanirbhar Bharat– a policy for a self-reliant India aimed at reducing imports and helping the country overcome these pandemic times. However, even with Atmanirbhar Bharat, the current account surplus has been reducing and the merchandise trade deficit is increasing. Furthermore, India’s current account has been in the positive largely banking on the higher earnings of the computer services sector. The initial growth of digitalization that the pandemic spurred in business may be slowed affecting the high earnings reported by the IT sector. Additionally, with the unlocking of the economy, the import of raw materials is on the rise. The most important raw material being oil which is becoming more and more expensive. All these changes point to the fact that India may witness a lower current account surplus, maybe even a negative one. An almost negative current account would mean a positive capital account which shows an influx of foreign capital signaling investor confidence in the Indian economy.

Further Readings

India’s huge current account surplus is a bane, not boon

India’s current account surplus moderates to $15.5 billion in Q2FY21: RBI

Current Account Definition