News Excerpt: India's Current account saw a rare net surplus of $5.7 billion in the first quarter of 2024. This means more money entered the country than left, helping to limit the deficit for 2023-24 to $23 billion, or 0.7% of GDP.

More detail about news: 

• Excluding the first pandemic year, this deficit is the lowest in seven years and the second-lowest in two decades.
• While this might seem like a cause for celebration, it is more a signal to be cautious.

Domestic Savings and Investments:

• One way to evaluate the current account is by looking at the difference between domestic savings and investments.
• If a country saves more than it invests, it has a surplus; if it invests more than it saves, it has a deficit.
• India’s significant investment needs cannot be fully met by the collective savings of its households, businesses, and government. Therefore, it typically runs a deficit of 1-3% of GDP.

Reason of Current Account Surplus:

• The Reserve Bank of India noted an increase in investments, driven by higher government spending and a booming housing sector.
• Rating company Crisil recently estimated investments at 33.7% of GDP in 2023-24, a 1.5 percentage point increase, implying a 33% savings rate for a 0.7% current account deficit. 
• A rising savings rate allows for greater investments while keeping the current account deficit stable.
• Even with a modest 2% deficit, a 33% savings rate would mean an investment rate of 35%, or ₹6 trillion available for nation-building. 
• Thus, a deficit resulting from strong savings and investments can still promote growth.

Demographic Profile:

• India's demographic profile is theoretically ideal for a high savings rate.
• An increasing share of the working-age population should boost production, income, and savings, while a declining fertility rate should lead to more women in the workforce.
• This demographic dividend increases labor strength and productivity.
• However, India’s savings rate hasn’t grown sufficiently in recent years due to issues like inadequate job creation, poor labor skills, and economic setbacks from demonetization and the pandemic.

Rising Investment Demand:

• Therefore, the current growth rate in savings is unlikely to meet the investment scale needed for strong economic expansion, resulting in a current account deficit.
• Drawing on overseas savings will be essential to benefit from the demographic dividend.

Foreign Exchange Inflows:

• India's markets are well-positioned to receive foreign exchange inflows.
• As one of the world’s fastest-growing economies, post-election investments that were on hold are likely to resume. If the US starts cutting rates before the year-end as anticipated, there could be a re-routing of global capital towards emerging markets, including India.

Challenges:

• The rupee has been one of the best-performing currencies this year in both nominal and real terms.
• However, geopolitical tensions and rising protectionism could cause even a moderate appreciation of the rupee to make India's exports more expensive and less competitive.

Current Account Deficit: Good or Bad?

• A current account deficit at this time could balance expected capital inflows and stabilize the rupee.
• A current account surplus isn't always good, nor is a deficit always bad. What matters is the quality and sustainability of the deficit or surplus.
• A deficit driven by investments in projects with sustainable future benefits is good.
• A surplus from unused savings due to a lack of domestic investment opportunities is bad.
• In India's case, a deficit caused by high gold imports is bad, as would be a surplus driven only by remittance inflows.

Global Scenario: 

• Half of the top 20 emerging markets have persistent current account deficits.
• The surplus countries are either oil-rich (Russia, Iran), export-oriented (China, Thailand, Korea), or rising export stars (Vietnam).

Conclusion:

The key takeaway is that instead of labeling a deficit as good or bad, India needs to build long-term export potential while creating an institutional environment that efficiently attracts and uses foreign capital to fund moderate deficits in the short term.