Sustainability of Current Account Deficit:
Theoretically speaking, a current account deficit can be sustained as long as the growth rate of national income exceeds the rate of interest on the nation's liabilities. Sufficient condition for sustainability of this deficit is a constant foreign debt - GDP ratio over a time period. In the reverse gear, non-sustainability implies
(a) large current account deficit - GDP ratio
(b) persistent low domestic savings rate on account of current account imbalance.
Implications and effects of persistent current account deficit are far and wide. For, foreign investors may take a pessimistic view of country's ability to meet its foreign obligations and even reduce the capital inflows. Second, a current account deficit represents an imbalance between demand for and supply of foreign exchange as a result of which there might be speculative attack on the currency, fiaught with serious consequences for the whole economy. Third, if caused primarily by widening trade deficit, a current account imbalance indicates structural competitiveness problem. Such a structural constraint is reflected in lower export - GDP ratio and continuous higher import - GDP ratio. Fourth, it has been empirically observed that high current account deficits are at the bottom of external payments crisis worldwide. A bench-mark suggests that a current account deficit (CAD) GDP ratio of 5 percent should be a cause for concern from the viewpoint of its sustainability.
Fifth, the size, composition as well as financing of the current account deficit is critical in determining the future sustainability sector. This becomes even more important when with the relaxing barriers to capital mobility, current account deficit can increase vulnerability of these economies to external shocks. The Mexican peso crisis of 1994-95, the East Asian currency turmoil of 1997, the Russian and Brazilian cisis of 1998-98 and that of Argentine of 2001-02 are reminder of the vulnerability of these economies to massive build-up of current account imbalances non-sustainability and proved disastrous for their financial stability.
In India, the issue of a sustainable current account deficit assumed crucial significance in the aftermath of 1990-91 crisis. A current account deficit of 3 percent of GDP triggered a crisis in India in the same year. It was argued in' some quarters that a distinct decline in invisible earnings during 1985-90 was a key factor in precipitating the crisis of 1990-91.
In terms of the size of the current account deficit, its range of 1.5 to 2.5 percent of GDP has been considered consisted with the stabilisation of India's net external liabilities. Further, the High Level Committee on BOP (Chaired by C. Rangarajan) recommended a CADI GDP ratio of 1.6 percent Similarly, the document on Tenth Five year plan (2002-07) projects a current account deficit of 1.6 percent of GDP as against 0.9 percent of GDP in the Ninth Plan.
This deficit was consistent with macro variables of domestic savings, investment and incremental capital output-ratio to achieve a growth rate of 8 over the plan period. What has been the experience of India in post reform period? Has current account deficit been consistent with macro variables and its projections during 1990s and beyond? These aspects merit some consideration.
As against many developing countries, the Indian experience turns out to be different from those countries with its high saving-investment correlation and low capital mobility (RBI, Report on Currency and Finance 2002-03 p. 132). Following RBI analysis, it can be said that a high positive saving - investment gap of the private sector was a reflection of stagnation in investment demand during a large part of 1990s. The negative public sector saving investment gap in India seems to have been adjusted within the economy without spilling over to the external sector. And thus despite massive fiscal deficit, India's current account deficit has remained insulated by rising private savings.