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Sustainable Level of India's Current Account Deficit

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Sustainable Level of India's Current Account Deficit
W P S (DEPR) : 16 / 2012

RBI WORKING PAPER SERIES

Sustainable Level of India’s Current Account Deficit

Rajan Goyal

DEPARTMENT OF ECONOMIC AND POLICY RESEARCH

AUGUST 2012

The Reserve Bank of India (RBI) introduced the RBI Working Papers series in March 2011. These papers present research in progress of the staff members of RBI and are disseminated to elicit comments and further debate. The views expressed in these papers are those of authors and not that of RBI. Comments and observations may please be forwarded to authors. Citation and use of such papers should take into account its provisional character.

Copyright: Reserve Bank of India 2012

Sustainable Level of India’s Current Account Deficit Rajan Goyal ∗ The paper estimates sustainable level of current account deficit (CAD) for India by applying a model akin to `Domar’s Model of Debt Sustainability’ to the threshold level of net external liabilities that economy should not breach to ensure stability of the external sector. Probit analysis based on a select panel of market economies was used to arrive at the threshold level. Study concludes that CAD between 2.4 to 2.8 per cent of GDP is sustainable over the medium term under the assumptions that GDP growth ranges between 6.0 and 8.0 per cent, inflation hovering around 5.0 per cent level and interest rate and size of capital flows broadly following their trends in the recent past.

JEL Classification: F32, F34 Key Words: Current Account, Sustainability, Capital Flows, Debt Service Ratio, Reserves Section 1: Introduction

Diverse experience across the globe shows that excessive current account deficit (CAD) tends to make economy vulnerable to external debt or currency crisis which brings in its wake financial instability and substantial output and welfare losses. In India, unrelenting expansion of fiscal deficit in the late 1980s spilled over to CAD that culminated in Balance of Payments (BoP) crisis of 1991, a situation perilously


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