How does current account deficit affects common man?

What is current account deficit?

Current account deficit is the difference between value of import and value of export.

If a country X exports goods and services worth Rs. 100 but imports goods and services worth Rs. 120, then there is difference or deficit of Rs. 20.

How does current account deficit can create a problem?

Let us take an example of India.

India imports oil from Saudi Arabia and exports softwares to USA.

Let us assume,  price of 1 barrel of oil = 1 dollar = 1 Rupee


Let us assume India imports 100 barrels of oil each year. So it has to pay 100 dollar i.e. 100 Rupee.

So , Price of 100 barrel of oil = 100 dollars = 100 Rupee

India exports 100 Rupees worth softwares. So it earns 100 dollars.

So India can pay its oil bills every year comfortably.

Now, assume in some year software requirement from USA becomes 50 dollars. Thus India gets only 50 dollars from exports. So India has to sell 100 Rupee worth software for 50 dollars.

50 dollars = 100 Rupees. So Indian currency becomes 2Rs/dollar. 

This shows currency depreciates whenever there is a trade deficit.

So India now has to pay 200 Rupees for 100 barrels of oil. Thus imports become costly.

As the import becomes costly inflation will happen because transportation costs will go up.This will increase prices of cement steel etc.So housing prices will go up.

In order to bring down this inflation RBI has to increase the REPO-RATE. Effect of repo rate has been discussed in the following blog post.

http://isheconomist.blogspot.in/2015/11/what-is-repo-rate-how-does-it-affect-me.html

Due to increase in Repo rate business will get loans at higher rate. So businesses will be reluctant to expand. So less number of jobs will be created.

Depreciation can also make foreign debts very costly. For explanation read following post
http://isheconomist.blogspot.in/2015/10/how-depreciation-of-currency-can-create.html


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