Sustainability of India’s current account deficit: Role of remittance inflows and software services exports

This paper examines current account sustainability and validity of inter-temporal budget constraint (IBC) for India. Sustainability of current account is established by estimating co-integrating relationship between exports and imports with and without invisibles, specifically software services exports (SSE) and private transfers (remittances) for the period 2000-2001:Q1 to 2016-17:Q3. The empirical model is estimated using Auto Regressive Distributed Lags (ARDL) technique to state that exports and imports are co-integrated in the long run and the IBC validity cannot be rejected for India. ARDL estimations for four alternative measurements of imports (with and without net invisibles, net remittances and net SSE) indicate that higher co-integrating coefficient in presence of net invisibles ensures greater current account sustainability. In addition, short-run shocks to the current account continue to persist for longer duration in the absence of net invisibles. The estimated long run co-integrating coefficients suggest that India’s current account is sustainable but in a weak sense, implying that increase in imports will percolate to higher dependence on foreign borrowings. Comparison of error correction terms across the specifications suggest that private transfers (remittances) have higher contribution in ensuring current account sustainability than SSE, as speed of adjustment towards equilibrium in the presence of remittances is higher than in presence of SSE.