The trend of various economic variables in India affecting its current account deficit

The main goal of a country’s macroeconomic policy is to maintain conditions that facilitate investments from external and internal sectors. The country has to maintain an internal balance between the sectors to keep a check on the economic variables such as unemployment rate, production output, and inflation. Also, it has to maintain an external balance to keep a check on the current account balance (Behera & Yadav, 2019).

India’s current account deficit has been a longstanding issue that policymakers have been grappling with. While the deficit has fallen to 1.5% of GDP from 2.6% in the third quarter of FY 2021-22, it remains a significant concern (RBI, 2022a). The fact that the net value of goods and services imported is greater than the value of those exported highlights the need for a comprehensive understanding of the economic variables that are driving these trends.

Despite the fall in the current account deficit, the persistent high value since the financial crisis of 2008 has been a major concern for the policymakers in India. India usually runs a deficit due to its reliance on imports thus it becomes imperative to get a clear understanding of the movements of economic variables to formulate effective policies for supporting economic development.

The trend of economic variables in India

Trend analysis is a method that concisely shows the fluctuations of the economic variables over some time, thus, this study aims to conduct a trend analysis of the macroeconomic factors to understand the economic status of India.

The Indian economy since the outbreak of COVID-19 has seen a sustained recovery in the FY 2020-21 2^nd half. Though the economic output is increasing to surpass the pre-COVID-19 situation, these statuses have not been just due to the rise in output (Government of India, 2022). The economic status of India is dependent on many economic variables or factors. These variables are prone to changes over time due to changes in policies, market conditions, or external shocks. An examination of these economic variables is necessary to understand and evaluate their impact on the economy and also to increase economic efficiency.

Current account balance of India

The Current Account Balance is the difference between the value of the goods and services imported and exported by a country. A current Account Deficit is when the value of the goods and services imported exceeds the value of exports (Behera & Yadav, 2019). This factor is important for India as it shows the Indian economy’s performance and its level of competitiveness. It also assists in making informed judgments in formulating economic policies and evaluating the country’s economic condition. (Tuovila & James, 2022)

From the above figure 2, it can be seen that the current account balance of India had been decreasing until 2003. It peaked and started declining until 2012 with a value of – USD 4796.1 billion. From there onwards, the country has been on the path of an increase that has continued to 2020 wherein the current account balance was USD 327.3 billion.

This variation in the current account balance and a deficit has been mainly due to trade imbalance. However, the existence of net capital inflows in the form of foreign investment inflow or revival in net external commercial borrowing contributed towards reducing the deficit in the current account balance (Government of India, 2022). With the outbreak of COVID-19 as domestic activities collapsed, thus, more reliance on imports further resulted in raising the current account deficit. Thus, the current account balance is not an effective measure to understand the economic status of India.

Performance of the economic variable GDP of India

The standard measurement of the value added produced via the production of goods and services in a nation over a specific time period is the gross domestic product (GDP). As a result, it also accounts for the money spent on final goods and services as well as the profits generated from that output. With a GDP of USD 3 trillion, India’s economy is considered to be the fifth largest in the world, with GDP being a key indicator of a nation’s financial health (RBI, 2022b).

The above figure 3 shows the GDP of India from 1993 to 2020. It is noted that there has been a consistent increase in GDP from the 1990s’ i.e. USD 279.30 billion to USD 3176.30 billion in 2021. This shows the level of development of the Indian economy over the years. This economic growth of India has been due to growing business activities, increased FDI, and initiatives of raising export output, income, and employment in the country.

Government expenditure and private investment in India since 1993

Government expenditure refers to the funds used by the public sector for social welfare, healthcare, education, and defence. Contrarily, private investment refers to financial assets other than those offered on the open market, such as cash, stocks, and bonds. The promotion of economic activity could result from increased government spending and private investment that aim to boost the economy (Muammil, 2018).

The above figure 4 shows the private investment and government spending levels from 1990 to 2020 in India. The graph shows that over the years, private investment has been on the rise while government spending has been on a decline. The rise in private investments has been due to efforts of the Indian government in the form of increasing its spending on infrastructure.

The Indian government is concentrating on expanding private investments since they help introduce technology, build capacity, create jobs, and stimulate demand (RBI, 2019). Nonetheless, the government’s attempts to cut borrowing, boost economic growth, and enhance tax revenue are what have led to the fall in government spending in India. So, it is important for an economy to support economic development activities and private investment and government spending are pertinent and complimentary words.

Performance of the economic variable trade openness

Trade openness is of indicator of how much a country participates in the world trading system. The ratio between the sum of total exports and imports and the GDP is typically used to gauge trade openness (GDP). A greater degree of openness leads to greater economic efficiency due to its relationship between imports, exports, and the GDP (Mallick & Behera, 2020).

Despite the fact that India was having issues with rising imports and falling foreign exchange, the implementation of trade liberalisation policies in 1991 and numerous other reforms led to a steady increase in the trade share of GDP. This not only encouraged the nation’s exports but also improved the manufacturing and service sectors (Sengupta, 2020).

From figure 5 above, it is imperative that trade openness has increased significantly from 19.86% since 1993. It reached its peak in the year 2012 with a rate of 55.79%. After which trade openness has been declining to 40.16% in 2017 and increased further to 43.38% in 2019.

The fluctuations in trade openness have been due to the prevalence of red tape in the Indian economy along with insufficient attention and efforts towards rural poverty, social services, or disease control (Irwin, 2021). But with the growing trade relations of India, the opportunities for enhancing trade openness increased which resulted in raising exports and bringing more opportunities for domestic businesses.

Fiscal deficit of India from 1993 to 2020

The difference between the total revenue and total expenditure of the government is the fiscal deficit of a country (Das, 2006). A fiscal deficit occurs when a country is spending more than its earnings. The presence of a negative balance represents fiscal deficit while a positive balance depicts fiscal surplus. For an economy, there is a need to maintain a positive balance as the existence of fiscal deficit results in an increased inflation rate (De, 2012).

From the above figure 6, it is seen that the fiscal rate has been gradually increasing since the 1990s i.e. USD 602.57 billion in 1993 and reached USD 18182.91 billion in 2020. This increasing trend shows the constant need of the Indian government to finance the needs of its consumers by borrowing which further worsened with the outbreak of COVID-19. The existence of a fiscal deficit not only disrupts the scope of growing demand but also distorts the financial sector of a country. Thus, in India, there is a need of having a well-planned and aggressive sale of government stakes in the public sector to finance the need (Sitharaman, 2022).

FDI inflow in India since 1993

Foreign Direct Investment (FDI) is the inflow of foreign capital that reflects the interest of one country received from another country (RBI, 2018). More FDI results in higher levels of investment in the home country, which boosts economic growth and productivity. Thus, FDI plays a significant role in India’s economic development. Aiming towards enhancing growth, financial stability, and a rise in growth rate, the FDI inflows in India provided a means of strengthening exports, savings, and domestic production (Shalini, 2020).

The above figure shows that the FDI net inflows in India have increased from 0.55 USD billion in 1993 to 64.36 USD billion in 2020. But with the outbreak of COVID-19, foreign investment in the country decreased resulting in a fall of FDI net inflows to 44.73 USD Billion. These FDI inflows over time have provided the means of development for the government and created opportunities of having technological advancement resulting in more employment and output generation (Vimlesh, 2016).

Effects of inflation and interest rate on the economic variables

The amount that a group of products and services have increased in price over time is measured by inflation. The same amount of money can now only buy a smaller number of items due to higher rates of inflation (or services). This decrease in purchasing power has an effect on living expenses, which slows economic growth (Ball et al., 2016).

Interest rate, on the other hand, is the amount that a lender charges a borrower for the use of borrowed money. It is expressed as a percentage of the principal amount borrowed and is usually charged on an annual basis. An increase in interest rates has significant effects on both the money and goods markets. Lower levels of investment in the goods market result in slower economic growth (Gowda, 2020).

A high inflation rate reduces the purchasing power of people and more interest rate reduces the money supply in the economy, thus a country’s macroeconomic policies focus on using interest rates as a tool to control inflation.

The above figure shows that the rate of inflation increased from 6.36% in 1993 to 13.23% in 1998. While the rate of interest changed from 5.81% to 5.12% but with the measures adopted by the Indian government to control inflation like raising the interest rate to 9.19% in 2009, the rate declined and reached the level of 3.76% in 2004.

However, due to the rise in crude oil prices and the reduction in domestic production in the agricultural sector, the inflation rate further increased to 11.99% in 2010 and the interest rate declined by -1.98% (Mohan & Ray, 2018). With the initiation of policies like more investment in the private sector and demonetization, the government of India focused on controlling inflation and managed to reduce the inflation rate to 3.72% in 2019 and an interest rate of 5.43% (Daniyal, 2021). However, with the outbreak of COVID-19, the inflation rate further increased which was again followed by a rise in the interest rate and a restriction on agricultural exports to control inflation.

The broad money supply of India since 1993

The amount of money in the economy at any given time is known as the “money supply”. The term “broad money” refers to a measure of the money supply in India that includes public currency, demand deposits with banks, and time deposits with banks. The Indian government is concerned with maintaining the level of money supply because having more money available gives the economy the chance to grow faster since there is more access to financing, which in turn regulates the corporate activity and meets consumer demand (Das, 2010).

The above figure shows the existence of an increasing trend in the money supply i.e. the level increased from 3931.75 USD billion in 1993 to 174074.11 USD billion in 2020. This consistent growth of money supply has been due to growing grant-oriented policies like MGNREGA which led to the overall rise in the currency.

Furthermore, a continuous surge in foreign money in India resulted in raised demand for the rupee in exchange for the dollar resulting in an appreciating rupee and raising the money supply (Kaul, 2020). Even to lower the interest rate, the government initiated activities to pump money into the economy. This constantly rising money supply puts pressure on the economy and creates a situation of raising inflation risk (Shubhada Sabade, 2014).

Exchange rate performance of India since 1993

The relative cost of one currency expressed as another currency is known as the exchange rate. It is essential for determining how well a country’s economy is doing since the exchange rate provides insight into how the home nation performs relative to other nations worldwide. Payments must be made in US dollars because India is heavily dependent on imports of electronics, crude oil, and metals. Due to the weak rupee, consumers must pay more for the same amount of goods, which puts pressure on inflation and the economy (Patnaik & Sengupta, 2021).

The above figure 10 shows that over time the value of the rupee depreciated i.e. the exchange rate increased from 30.49 in 1993 to 73.92 in 2021. The weakening of the rupee in India has made exports more competitive and increased the purchasing power of foreign buyers, thus raising exports. But the presence of persistent volatility and weak global demand results in limiting the support of exchange rate to exporters and creating a burden of inflation due to high crude oil prices for the economy (Outlook, 2022).

Further statistical research will be needed to fully examine the correlation between the economic variables because the aforementioned trends only provide rudimentary information regarding movement and do not establish the relationship between elements. The next articles will concentrate on evaluating how the economic variables affect GDP and the current account deficit. It is important to be aware of the elements influencing a measure’s variance when formulating policies and making any economic decision.

References

• Ball, L., Chari, A., & Mishra, P. (2016). Understanding Inflation in India. NBER Working Paper Series.
• Behera, H. K., & Yadav, I. S. (2019). Explaining India’s current account deficit : a time series perspective. Journal of Asian Business and Economic Studies, August. https://doi.org/10.1108/JABES-11-2018-0089
• Daniyal, S. (2021). Why is the Modi government failing to control India’s inflation? QUARTZ.
• Das, R. (2006). Governance of Fiscal Deficit in India. JEL, June. https://doi.org/10.13140/RG.2.1.3454.4809
• Das, R. (2010). Definitions and Measures of Money Supply in India. MPRA, 65162.
• De, S. (2012). Fiscal Policy in India : Trends and Trajectory.
• Government of India. (2022). Economic survey 2021-22.
• Gowda, R. (2020). GDP – Inflation – Interest Rate : Nexus in India. International Journal of Humanities and Social Science Invention (IJHSSI), 9(8), 42–48. https://doi.org/10.35629/7722-0908034248
• Irwin, D. A. (2021). India’s trade reforms 30 years later: Great start but stalling. PIIE. https://www.piie.com/blogs/trade-and-investment-policy-watch/indias-trade-reforms-30-years-later-great-start-stalling
• Kaul, V. (2020). A surging money supply is behind MPC’s status quo. LiveMint. https://www.livemint.com/news/india/a-surging-money-supply-is-behind-mpc-s-status-quo-11602434568097.html
• Mallick, L., & Behera, S. R. (2020). Does trade openness affect economic growth in India? Evidence from threshold cointegration with asymmetric adjustment. Cogent Economics & Finance, 8(1). https://doi.org/10.1080/23322039.2020.1782659
• Mohan, R., & Ray, P. (2018). Indian Monetary Policy in the Time of Inflation Targeting and Demonetisation. Brookings India Working Paper.
• Muammil, S. (2018). The effect of government expenditure and private investment on work opportunities and unemployment rate in Indonesia. RJOAS, 4(April), 92–100.
• Outlook. (2022). Why Is Rupee Falling And How Will It Impact The Indian Economy And People ?
• Patnaik, I., & Sengupta, R. (2021). Analysing India’s Exchange Rate Regime. NIPFP Working Paper Series, 353.
• RBI. (2018). FDI in India: History, Policy and the Asian Perspective. Reserve Bank of India Occasional Papers, 39(1).
• RBI. (2019). Economic Survey 2018-19.
• RBI. (2022a). Developments in India’s Balance of Payments during the Fourth Quarter (January-March) of 2021-22.
• RBI. (2022b). India’s Gross Domestic Product.
• Sengupta, S. (2020). How to trade openness influenced economic growth in India : An empirical investigation. Indian Journal of Economics and Development, September. https://doi.org/10.17485/IJED/v8.21
• Shalini, S. (2020). The Role of Foreign Direct Investment ( FDI ) in India- An Overview. SSRN Electronic Journal, August.
• Shubhada Sabade. (2014). Is money supply the cause of inflation in India? An alternative postulate to understand inflation. Procedia – Social and Behavioral Sciences, 379–382.
• Sitharaman, N. (2022). Statements of Fiscal Policy as required under the Fiscal Responsibility and Budget Management Act, 2003. Ministry of Finance.
• Vimlesh. (2016). Role of FDI in the Economic development of India. IJARIIE, 5, 1474–1479.