Effects of Current Account Deficit on the Value of Indian Rupee

Abstract

In economics, a country's current account is one of the two components of its balance of payments, the other being the capital account (sometimes called the financial account). The current account consists of the balance of trade, net primary income or factor income (earnings on foreign investments minus payments made to foreign investors) and net cash transfers that have taken place over a given period of time. A country's balance of trade is the net or difference between the country's exports of goods and services and its imports of goods and services, ignoring all financial transfers, investments and other components, over a given period of time. A country is said to have a trade surplus if its exports exceed its imports and a trade deficit if its imports exceed its exports. Positive net sales abroad generally contribute to a current account surplus; negative net sales abroad generally contribute to a current account deficit (CAD). In any country's economy the Current Account Deficit (CAD) is the one of the key indicators of Macro Economic stability. In this paper we analyse India's CAD situation and how changes in the CAD affects the rupee stability. We build a model that explains the effects of CAD on the value of the domestic currency (Rupee). Indian economy and currency (In-terms of $) is taken up as a case study for building the model and discussed for the effects and conclusions based on hypothetical data. Since most of the payments done by India are in US Dollars, the model takes in to account the Supply and Demand functions for the Dollar and its effect on the local currency fluctuations. The model also explains how the currency fluctuations in-turn contributes to widen the CAD and finally leading to currency crisis.