Question

Consider the following statements:

(1) Hike in global oil prices can widen the Current Account Deficit (CAD) of India.

(2) Higher CAD can lead to depreciation of the currency.

Which among the above statements is/are correct?

1. Only (1)
2. Only (2)
3. Both (1) & (2)
4. Neither (1) nor (2)

Answer 1

Correct Answer - Option 3 : Both (1) & (2)

The correct answer is Both (1) & (2).

• Current Account Deficit or CAD is the shortfall between the money flowing in on exports, and the money flowing out on imports.
• Current Account Deficit measures the gap between the money received into and sent out of the country on the trade of goods and services and also the transfer of money from domestically-owned factors of production abroad. 
• The Current Account records exports and imports in goods and services and transfer payments.
• Trade-in services denoted as invisible trade includes both factor income (payment for inputs-investment income, that is, the interest, profits, and dividends on our assets abroad minus the income foreigners earn on assets they own in India) and non-factor income (shipping, banking, insurance, tourism, software services, etc.).
• Transfer payments are receipts that the residents of a country receive for free, without having to make any present or future payments in return. They consist of remittances, gifts, and grants.
• CAD rises/widens when the value of goods and services a country imports exceeds the value of goods and services it exports.
• The rise in international crude oil prices led to the depreciation of rupees because our country imports more than 85% of crude oil.
  • The increased rate of crude oil led to the current account deficit (CAD) of India will increase. Hence statement 1 is correct.
  • In such a situation, the Supply of rupees has to increase, the increased supply of rupees led to lowering the value of rupees and it starts depreciating. Hence statement 2 is correct.