Current Account Deficit, FDI and Rupee Pressure
An economy's external transactions for a year are as follows, in ₹ crore: merchandise exports 600, merchandise imports 900, export of software services 200, import of shipping services 100, remittances from workers abroad 150, and foreign direct investment inflow 100. The central bank follows a managed float and initially holds foreign exchange reserves of ₹250 crore. There is no valuation change. A newspaper headline says a record trade deficit proves the rupee must fall. An exporter says the overall balance is in surplus, so the rupee should appreciate. You are asked to compute the current account balance and overall balance, identify the pressure on the rupee, and assess what the central bank should do if FDI inflow falls to ₹40 crore next year while the other items remain unchanged.
1. Compute the current account balance and the overall balance. Is the trade deficit the same as the current account deficit? What pressure does the overall balance put on the rupee?
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Current account:
Goods balance = 600 − 900 = −300.
Services balance = 200 − 100 = +100.
Remittances = +150.
Current account balance = −300 + 100 + 150 = −50 crore.
Capital account = +100 crore (FDI).
Overall balance = current account + capital account = −50 + 100 = +50 crore.
The trade deficit is 300, but the current account deficit is only 50 because services exports and remittances offset 250. The headline confuses the two.
The overall surplus of 50 means that, at the current exchange rate, inflows exceed outflows. There is excess supply of foreign exchange, which would tend to appreciate the rupee. Under a managed float, the central bank can buy the excess foreign exchange and add ₹50 crore to reserves, preventing or limiting appreciation. So the market pressure is toward appreciation, not depreciation, as long as FDI remains at 100.
2. If FDI falls to ₹40 crore next year and all other items are unchanged, compute the new overall balance and explain the adjustment options available to the central bank.
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Current account stays at −50.
Capital account becomes +40.
Overall balance = −50 + 40 = −10 crore.
The economy now has an overall deficit of ₹10 crore. At the current exchange rate, demand for foreign exchange exceeds supply, putting downward pressure on the rupee.
The central bank can sell ₹10 crore of reserves to defend the rate. It has ₹250 crore, so this is feasible for a year. But reserves are finite, and repeated intervention would drain them.
Alternatively, it can allow gradual depreciation. A cheaper rupee makes exports and software services more competitive and makes imports dearer, which should narrow the current account deficit over time. The risk is imported inflation, especially for essential imports, and higher costs for firms using imported inputs.
A sensible judgement is to use reserves to smooth a temporary ₹10 crore shortfall, while allowing some depreciation and encouraging stable non-debt inflows if the deficit persists.
3. Evaluate the exporter's claim that an overall surplus means the rupee should appreciate. Does the claim follow as a prediction, and what does it imply for exporters?
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An overall surplus does create excess supply of foreign exchange and therefore pressure for the rupee to appreciate. But under a managed float, that pressure need not produce actual appreciation. The central bank can buy foreign exchange and accumulate reserves, keeping the rupee stable.
The surplus also depends on the composition of inflows. FDI of ₹100 crore is not guaranteed to continue; if it is volatile or reversed, the apparent surplus can disappear, as the fall to ₹40 crore shows. A surplus driven by temporary inflows is a weak basis for predicting permanent appreciation.
The exporter's claim is therefore not a reliable prediction; it is also self-interested, because appreciation makes exports dearer in foreign currency. A better policy judgement is to look at the current account, the durability of capital inflows, and the central bank's intervention stance together. Exporters should prepare for possible appreciation but cannot assume it from one surplus year.