• Who’s afraid of a big current account deficit?813530
  • What is the CAD?
  • What if there was no capital account?
  • Should we bemoan the large Indian CAD?
  • A big CAD got us into trouble in 1991. Won’t that happen again?
  • Why won’t all channels choke all at once?
  • What kinds of foreign investors respond the most to rupee depreciation?
  • Why is a large CAD seen as a big problem?
  • What is the role of MOF or RBI in ensuring adequate capital comes into the country to match the CAD? 

Most of these FAQ been answered by Prof.Ajay shah during the illuminating discussions with Josh Felman. People always have perceptions and views on the CAD, A big CAD is a bad thing — much like a big fiscal deficit.

A country is always better off with a small or zero CAD or ideally a surplus.

The CAD is a drag on growth.

The large CAD is a profound drag on India’s outlook.

If we managed to reduce the CAD, things would get better.

Well according to Shah these all statements are wrong .

To put in lay man language CAD is three things, all of which are identical. It is the gap between revenues from selling goods and services versus the payments made for buying goods and services. This has to be exactly matched by the capital inflow into the country. This is exactly equal to the gap between investment and savings. These three relationships are accounting identities.

If there was no capital account, then the proceeds from selling goods and services would have to exactly match the payments for goods and services, in every minute. Every small mismatch between the two would generate extreme currency fluctuations (large enough to incite a current account response).

Should you be unhappy that investment is bigger than domestic savings by 5 per cent of GDP? If we insisted that the CAD should be 0 (i.e. we had no capital account) then investment would have to be lower and savings would be higher (which in turn implies reduced consumption). This would give reduced GDP growth.

In 1991, FERA (1973) was in force. Capital account transactions by private parties had been criminalised. The only mechanism that generated flows on the capital account was the government. The entire CAD had to be financed by government borrowing. When the government lost creditworthiness in the eyes of the world, we had a funding crisis on the capital account.

We require a capital inflow, on average, of Rs.20 billion per day. That’s the gap, on the currency market, which has to be filled. If foreign capital does not come in, there is a supply demand mismatch on the currency market. This gives a currency depreciation. Ex-post, supply always equals demand. On the market, this demand will be met. Every day, the CAD of the day will equal the capital inflow of the day. The only question is: At what price?

Sharp spikes of the rupee are fertile ground for currency speculators. The more currency speculators that we have, who are operating on the rupee market, the smaller is the INR movement associated with an event.

With a large CAD, India is beholden to foreign capital inflows. If foreign investors are displeased, we get a big rupee depreciation. This generates accountability. When India enacts capital controls, or the Food Security Bill, we get a rupee depreciation. This irritates policy makers, who feel that mirrors should reflect a little before throwing back images.

Nobody likes accountability. Hence, people in positions of power do not like a large CAD.

The widespread mistrust of a large CAD may reflect two things. Some don’t see the extent to which we’re not in 1991 anymore: there is much more of a deep engagement with financial globalisation, and the exchange rate floats enough that the borrowers are not unhedged. And, establishment figures resent accountability.