India reported an all-time high current account deficitof 4.2% of GDP in 2011-12 and trade deficit of about 10% of GDP.
However, economists say these deficits will be under control as the J curve effect comes into play. ET looks at the concept of the J curve.
What is 'J' curve?
The J curve is used to illustrate a movement in a variable's, which falls initially but rises up to higher levels than before in the shape of the letter 'J'.
When applied to a country's external account, it says that whenever there is depreciation in the currency's value, the trade deficit initially worsens as imports become more costly and exports take more time to react.
Over time, depreciated currency makes exports competitive while imports slowdown as cheaper domestic output replaces imports. This shift causes trade balance to improve.
What's its significance?
The curve shows that depreciation of a currency due to deterioration in a country's external balances is actually a part of the solution.
If the depreciation is managed properly through intervention to reduce volatility, then it will help correct the imbalances.
Why is it relevant in the Indian context?
The rupee has depreciated from around `49 a dollar to `57 since the start of the year, but has recently bounced back to around Rs 55. This has worsened current account as a large portion of imports, including crude oil, is price inelastic in the short run.
But economists expect imports to come down in future as costlier inputs dampen demand, as evident in the case of gold.
Simultaneously, exports will pick up as they have become more competitive/cheaper in the global market. This will lead to an improvement in trade balance & consequently in Current account deficit.
What could hamper 'J' shaped recovery in external account?
While India's exports have become more competitive due to the massive devaluation of the rupee, global growth has also stumbled which will limit the demand for India's exports.
Also if the country does not pass on higher fuel costs to consumer, the demand for imported crude will not come down.
However, economists say these deficits will be under control as the J curve effect comes into play. ET looks at the concept of the J curve.
What is 'J' curve?
The J curve is used to illustrate a movement in a variable's, which falls initially but rises up to higher levels than before in the shape of the letter 'J'.
When applied to a country's external account, it says that whenever there is depreciation in the currency's value, the trade deficit initially worsens as imports become more costly and exports take more time to react.
Over time, depreciated currency makes exports competitive while imports slowdown as cheaper domestic output replaces imports. This shift causes trade balance to improve.
What's its significance?
The curve shows that depreciation of a currency due to deterioration in a country's external balances is actually a part of the solution.
If the depreciation is managed properly through intervention to reduce volatility, then it will help correct the imbalances.
Why is it relevant in the Indian context?
The rupee has depreciated from around `49 a dollar to `57 since the start of the year, but has recently bounced back to around Rs 55. This has worsened current account as a large portion of imports, including crude oil, is price inelastic in the short run.
But economists expect imports to come down in future as costlier inputs dampen demand, as evident in the case of gold.
Simultaneously, exports will pick up as they have become more competitive/cheaper in the global market. This will lead to an improvement in trade balance & consequently in Current account deficit.
What could hamper 'J' shaped recovery in external account?
While India's exports have become more competitive due to the massive devaluation of the rupee, global growth has also stumbled which will limit the demand for India's exports.
Also if the country does not pass on higher fuel costs to consumer, the demand for imported crude will not come down.
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