Markets
More pain ahead as current account deficit widens
Summary
While imports face upside pressures, exports may continue to underperform amid subdued global growth dynamics. Resilient domestic economic growth, nascent recovery in capex cycle and festival spending should drive import demand.
The latest balance of payments data is far from inspiring. India’s current account deficit (CAD) for the June quarter (Q1FY24) has widened to 1.1% of gross domestic product (GDP) from 0.2% in the March quarter. The deterioration is broad-based with worsening goods trade deficit and drop in services surplus as well as remittances from abroad.
The pain is unlikely to stop here as a slew of factors is likely to exert upward pressure on CAD for the rest of FY24. First, the goods trade deficit is set to expand.
While imports face upside pressures, exports may continue to underperform amid subdued global growth dynamics. Resilient domestic economic growth, nascent recovery in capex cycle and festival spending should drive import demand.
The recent uptick in global crude oil price may push the oil import bill higher. Plus, gold import demand may also rise in the upcoming festival and wedding season.
To be sure, India’s trade deficit has already widened to a 10-month high in August as exports continued to contract at a faster pace than imports.
Second, services surplus, a strong pillar for CAD, narrowed in Q1, for the first time in several quarters. What is more, services exports growth has been moderating in recent months and government estimates point to a contraction in August.
Third, remittance inflows have slowed in the last two quarters and may continue to face pressures as global growth is underwhelming.
According to Madhavi Arora, lead economist at Emkay Global Financial Services, the September quarter will see substantial widening of CAD led by the sequential worsening of trade balance driven by higher oil, higher core imports and further slowing services exports. “All of this will imply Q2 CAD to GDP ratio could be more than double of Q1FY24, ranging 2.4-2.6%," said Arora.
Meanwhile, there is some good news on capital account front, which was in surplus in Q1. India’s balance of payments is the sum of both current and capital accounts.
The cheer on capital account may be short-lived, though.
Long-term foreign direct investment (FDI) inflow in Q1 was lower year-on-year and sequentially, despite robust domestic growth and supportive FDI policies. Note that the capital account surplus in Q1 was completely driven by a rebound in two components—banking capital and foreign portfolio investors (FPI) flows.
While the former is extremely volatile over the last few quarters, the latter has its own set of challenges.After a steady positive run, FPI inflows into Indian markets have turned negative in September, as per NSDL data. While India’s growth prospects are viewed as comparatively attractive, stock market valuations are pricey.
Further, FPI inflows in the debt market could come under pressure as interest rates in the US may stay higher for longer. Here, a silver lining, however, is the inclusion of India’s sovereign bonds in the JP Morgan GBI-EM index, which is likely to facilitate higher capital flows into domestic bond markets. But that is largely a story for the next fiscal year.
For now, some pressure on India’s balance of payments looks imminent. This is likely to exert additional pressure on the Indian rupee, which has already lost some ground in recent weeks. In this context, focus on reviving exports both on the goods and services front along with attracting long term FDI inflows will be crucial in keeping external sector vulnerabilities at bay and rupee depreciation in check.
