The current account measures the flow of goods, services and investments into and out of the country. We run into a deficit if the value of the goods and services we import exceeds the value of those we export. The current account includes net income, including interest and dividends, and transfers, like foreign aid.
How a country can reduce its current account deficit?
A country can reduce its current account deficit by increasing the value of its exports relative to the value of imports.
It can place restrictions on imports, such as tariffs or quotas, or it can emphasize policies that promote export, such as import substitution, industrialization or policies that improve domestic companies’ global competitiveness.
The country can also use monetary policy to improve the domestic currency’s valuation relative to other currencies through devaluation, which reduces the country’s export costs.
Is current account deficit always disadvantageous?
While a current account deficit can imply that a country is spending “beyond its means,” having a current account deficit is not inherently disadvantageous.
If a country uses external debt to finance investments that have higher returns than the interest rate on the debt, it can remain solvent while running a current account deficit. If a country is unlikely to cover current debt levels with future revenue streams, however, it may become insolvent.
Current account deficit targets
The RBI wants to see the current account gap within 2.5% of the GDP, which is seen as crucial for currency stability. For example, the Current account deficit touched a high of 4.8% of the GDP in 2012-13 on rising gold and oil imports, which also impacted the rupee that depreciated rapidly. High current account deficit forced the government to impose import restrictions on non-essential items like gold.