Indianomics: Is current account deficit at 3% a worry?

Post the announcement of this data, many economists have revised higher current account deficit for the current year from around two percent to around three percent of GDP.

Former Reserve Bank of India (RBI) governor YV Reddy said that if under normal oil prices our current account deficit is likely to touch three percent, it merits very close attention.

CNBC-TV18 caught up with Sonal Varma, chief economist at Nomura; Sajjid Chinoy, chief economist at JPMorgan and Ashima Goyal Member of PMEAC to find what should the government and the RBI do about these trends in trade deficit.

Speaking on current account deficit, Varma said, "It does look like this year we will end up between 2.5-3 percent of GDP. There have been few studies including by staff at the RBI on what the sustainable level of current account is, given a certain growth level and those estimates have been around 2.5 percent of GDP. The big change this year clearly is the global funding environment and whatever be our sustainable current account deficit for our growth rate, the fact is that, if the global funding environment is changing, then countries need to squeeze down on the extent of their current account deficit and that is the situation we are in. There is a problem on the balance of payment (BoP) funding and unless we take measures to squeeze down our current account deficit, there will be pressure on the currency to depreciate, which has other implications on the macroeconomic front."

Talking on trade deficit and its impact on current account deficit, Chinoy said, "It's important to understand that the current account problem is not one of last month or last quarter. We have been saying this for a while and YV Reddy alluded to this. To understand what the underlying current account is, you got to strip away oil and gold. If you do that, what you find is a very worrying trend that the current account surplus that India runs, ex-oil and gold, has actually deteriorated by almost three percent of GDP over the last three years. There has been a secular deterioration in these external imbalances and those were masked by very low oil prices. So the minute oil prices jumped back to any degree of normalcy, you are seeing the headline number jump up."

Chinoy said, "Now, why is this happening? It's happening because exports have underperformed the global economy even accounting for this deglobalisation and the fact that imports have been unduly strong despite the fact that India's growth differential with the rest of the world has narrowed. So we are seeing this on both sides of the ledger. Classical economic theory would suggest this requires expenditure switching. We need to have a real depreciation of the currency to boost export competitiveness, to make imports more expensive, and therefore boost import competing sectors."

Chinoy further added, "What we found in an empirical work recently is that the elasticity of exports to the exchange rate is much higher than previously presumed. So two points I will make. One is this underlying worsening of the current account has been a work in progress for the last four years. It's not a two month phenomenon and secondly, India will require some degree of expenditure switching, which is some real depreciation of the currency to compress these imbalances. I think currently the policies that the central bank and government is following is actually a very sound one to get a gradual calibrated depreciation of India's exchange rate."