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Is the Trade Deficit and the CAD Really a Worry?

05 August 20225 mins read by Angel One
Is the Trade Deficit and the CAD Really a Worry?
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Quite often the trade deficit and the current account deficit (CAD) are used interchangeably. There is a subtle difference between the two. While trade deficit refers to the excess of merchandise imports over merchandise exports, the CAD looks at the net effect of trade in services and remittances too. The CAD is a more revealing picture for a country like India because India has traditionally run a deficit on the trade account but a surplus on the services account. Over the last year or so, the trade deficit has shown a sharp rise and that is a cause of worry. Let us see how the trade deficit and the CAD panned out in the recent past…

As can be seen from the above chart, barring the month of September, the merchandise trade deficit has been above $10 billion in all the months. In fact, the cumulative trade deficit of $154 billion for the first 11 months of the year hints at an average monthly trade deficit of $14 billion. We may close the year with a trade deficit in excess of $170 billion. The trade deficit has been rising through the year due to a mix of higher crude oil prices and higher gold imports. The real worry could be on the total imports front. The total import bill for the fiscal year 2017-18 is likely to end up at $470 billion. That means, the current forex reserves of $421 billion will be sufficient to cover just about 10 months of imports. That is not a very comfortable scenario especially if benchmarked against other BRICS nations.

Why current account deficit could be the bigger problem?

As we saw earlier, the current account deficit (CAD) covers the trade deficit, services surplus, the secondary income surplus and the primary income gap. The CAD is normally measured and presented quarterly and that is one of the key parameters that determine the value of the currency and the external ratings of the country. So, how exactly has the current account deficit panned out over the last few quarters?

The current account deficit was just about 1.3% of GDP in the quarter ended December 2016 but for the quarter ended December 2017 it has sharply gone up to 2% of GDP. Why is this relevant? The 2% mark is normally considered to be the tipping point for the CAD to begin having an impact on the currency value. We have seen the impact from the rupee weakening beyond the65/$ mark and this situation could get exacerbated if the CAD widens further. Normally, 2% level of CAD is a call to action for the government and it may be recollected that S&P had refused to upgrade India’s sovereign ratings largely because of India’s vulnerability of the CAD.

Is the rising trade deficit and CAD a worry for India?

India currently has around 10 months of forex cover for its imports and that may not be too alarming. But it is high time the alarm bells start ringing and policymakers start looking at this seriously. So, while there may not be reasons for India to lose sleep over the issue, there are some key factors to keep a watch on…

  • Crude oil prices could hold the key to the trade deficit and the CAD. After touching a high of $70/bbl, Brent corrected to around $65/bbl but bounced back. In the last 1 year the rising crude prices have been substantially responsible for the sharp rise in the trade deficit and the CAD. With the OPEC supply cuts continuing and the Saudi Aramco IPO slated to hit the market shortly, it is unlikely that the crude oil prices could really come down sharply any time soon.
  • India’s export growth has been a matter of worry. On the one hand, the INR has remained strong through last year and that has dampened exports performance. Secondly, the “Make in India” campaign was supposed to give a boost to Indian exports but nothing of that kind appears to have happened on the ground.
  • If you look at the trade figures a couple of years back, the merchandise trade deficit was almost entirely compensated by the surplus on the services account. That is no longer the case as the biggest service exporter, Information Technology, has been suffering from weak pricing power and a structural shift in the demand dynamics of the industry.

The forex reserves at around $421 billion are still comfortable but if the rupee weakens from current levels then the RBI may enter the market to support the rupee and that could deplete the forex reserves. The depletion will e nowhere close to what Russia saw in 2015 and 2016 but it will be a risk, nevertheless. India needs to be cautious on this front.


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