Dalvoy Logo
Dalvoy
UPSC MainsGeneral Studies Paper IIIIndian EconomyPractice question

Current Account Deficit Factors and Economic Impact

What are the factors that influence current account deficit in India? Discuss the impact of high current account deficit on the Indian economy.

Discuss~250 words2 min readmedium
Attempt it first, timed · optional

Write the answer on paper, as in the exam. Start the timer, keep to the word target.

00:00/ 11 min · 250 words

Done writing? Photograph the sheet and see how it scores against this model answer, with feedback on what to fix.

Upload your answer sheet

How to approach

Begin by defining the Current Account Deficit (CAD) along with recent data from the Economic Survey. Examine the key factors influencing CAD in India, distinguishing between merchandise trade, invisibles, and macroeconomic variables. Conclude by analyzing the ramifications of a high CAD on the domestic economy and suggesting policy measures for external sector resilience.

Model answer

321 words

Introduction

Current Account Deficit (CAD) measures the shortfall between a country's foreign exchange receipts and payments arising from trade in goods, services, and unilateral transfers. According to the Economic Survey 2023-24, India's CAD narrowed significantly to 0.7% of GDP in FY24, reflecting resilient services exports and moderating merchandise import bills.

Factors Influencing Current Account Deficit in India

  • Merchandise Trade Deficit: Structural reliance on imported energy (around 85% of crude oil needs are imported), electronics, and strong domestic demand for gold consistently widen the trade gap.
  • Surplus in Net Invisibles: India's strong competitiveness in software and business services exports, along with robust inward remittances (surpassing $120 billion in 2023), serves as a crucial cushion offsetting merchandise deficits.
  • Global Commodity Cycles and Geopolitics: Sharp surges in international crude oil and fertilizer prices directly swell India's import bill.
  • Savings-Investment Gap: Macroeconomically, CAD reflects domestic investment outpacing domestic savings, requiring foreign capital to bridge the gap.
  • Exchange Rate Fluctuations: Volatility in the Indian Rupee alters export competitiveness and changes the nominal cost of servicing import bills.

Impact of High Current Account Deficit on the Indian Economy

  • Currency Depreciation: Excessive demand for foreign currency depletes foreign exchange reserves, exerting downward pressure on the Rupee.
  • Imported Inflation: Rupee depreciation inflates the landing cost of critical, inelastic imports like crude oil and edible oils, feeding into domestic retail inflation.
  • Risk of Capital Outflows: An unsustainable CAD weakens macroeconomic stability, prompting sudden foreign portfolio investment (FPI) outflows and heightening the risk of sovereign rating downgrades.
  • Accumulation of External Debt: Persistently wide deficits force reliance on volatile short-term debt and External Commercial Borrowings (ECBs) to finance the shortfall, increasing external vulnerability.

Conclusion

While a moderate CAD of 1.5% to 2% of GDP driven by productive capital goods imports can support economic expansion in a developing nation, elevated deficits threaten macroeconomic stability. Sustained external resilience requires boosting manufacturing export competitiveness through Production Linked Incentive (PLI) schemes and deeper integration into global value chains.

Key facts to remember

definition
Current Account Deficit (CAD)

An economic indicator representing the condition where a nation's total imports of goods, services, and transfers exceed its total exports over a given period.

statistic

India's Current Account Deficit narrowed to 0.7% of GDP in FY24, down from 2.0% of GDP in FY23.

— Economic Survey 2023-24
statistic

India remained the top remittance recipient globally, receiving over $120 billion in inward remittances in 2023.

— World Bank Migration and Development Brief

Frequently asked questions

Is a Current Account Deficit always bad for an economy?

No. For an emerging economy like India, a moderate CAD (around 1.5-2% of GDP) is often necessary because it reflects capital goods and technology imports that build future productive capacity.

← All questions on this topic (121)