14 Mar 2018 16:58 IST

CAD: a country’s recurring financial transactions with the rest of the world

A current account deficit indicates that a country’s spending is higher than what it earns from the world

President Donald Trump has begun playing his campaign trump cards one at a time. The latest one, which has roiled global trade, is the decision to slap higher import tariffs on steel and aluminium. The US is busy upping its import tariffs on a range of goods to prune its trade deficit and thus, its Current Account Deficit (CAD), a key indicator that reflects the economic strength of a nation. Trump’s targets are the nations which run up huge trade deficits with the US. The US has the highest trade deficit of $375 billion (in 2017) with China, followed by Mexico ($71 billion), Japan ($68 billion). With a deficit of around $23 billion, India isn’t off the hook.

What is it?

A current account reflects the net results of a country’s recurring financial transactions with the rest of the world. Trade in goods and services, net income from foreign investments and direct money transfers are the usual components of CAD. Trade includes both export and import of physical goods and services. Income from foreign investments includes dividends and interest. Direct transfer is all money remitted to a home country by its citizens working abroad. If the net value (credit minus debit) of all these components is positive, then its current account is said to be in surplus. A negative value indicates that the country runs a deficit (CAD). Trade in goods and services is the biggest component in the current account. That’s why Trump is training his guns on trade flows to contain CAD.

Why is it important?

CAD indicates that a country’s spending is higher than what it earns from the rest of the world. When a country runs a CAD for years at a time, it contributes to a steady outflow of foreign exchange and weakens its exchange rate. Take for instance, India’s persisting trade deficit ($16.3 billion in January 2018) has always kept its current account balance under pressure. The result has been a steadily depreciating rupee against other currencies. A widening trade deficit also indicates that a country’s domestic producers are finding it tough to compete effectively with their global counterparts, prompting consumers to depend on imported products.

Why should I care?

The US accounts for 15 per cent of India’s exports. Precious metals, jewellery and pharma products together contribute over 30 per cent of India’s exports to the US. Some of India’s largest job-creating sectors are heavily reliant on exports. Therefore, any measure by the US to shrink its trade deficit with India could hit these sectors and worsen the jobs problem. It is not just in the case of goods that India has a lot to worry about. Trump’s move to curtail new H1-B visas for entry-level programmers and rethink visa extensions for those whose green card applications are under process have already jolted the Indian IT industry and the Indians residing in the US - the top destination accounting for over 55 per cent of its services exports.

Its impact on India apart, US aggression on curbing imports can unleash global trade wars that can unsettle the nicely recovering global economy. If Trump decides to target nations like China in a bid to curb the CAD, it could attract retaliation in the form of trade or financial counter-moves from China. Such measures can in turn accelerate the trend of de-globalisation. This wouldn’t be great news either for the Indian economy or its stock market.

The bottomline

For every action, there is an equal and opposite reaction. Prepare for some fireworks.

(The article first appeared in The Hindu BusinessLine.)

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