Markets
Balance of payment data gives fewer reasons to cheer
Summary
The drop in current account deficit (CAD) was on account of lower goods trade deficit, robust services surplus, and remittances. But some of this could be short-lived.
The latest balance of payments (BoP) data was a mixed bag. While there are reasons to cheer, they are not plenty. Even as the current account saw a significantly lower deficit of 0.2% of gross domestic product in January to March (Q4FY23), it was a tad disappointing for some economists who were expecting a surplus. The drop in current account deficit (CAD) was on account of lower goods trade deficit, robust services surplus, and remittances. But some of this could be short-lived.
Already, goods trade deficit has started to widen, breaching $20 billion in May as exports fell faster than imports. This trend is likely to sustain through FY24 amid significant growth differential between India and the rest of the world. Sure, easing commodity prices may cap the import bill. However, strong domestic economic momentum and higher capital spending may keep underlying import demand intact at a time exports are facing challenges from a global slowdown. Indeed, the services surplus is robust, but it is showing signs of fatigue since March, dragged by the drop in exports.
With the current account likely to remain in deficit in FY24, a resilient capital account surplus will be crucial to contain the impact of external vulnerabilities. But that has not played out yet. Capital account surplus fell in Q4, lowering BoP surplus despite a sharp narrowing in CAD. The BoP of an economy is the sum of current and capital accounts. A surplus BoP reflects net accretion in the central bank’s foreign exchange reserves.
This decline in capital account was led by a sharp dip in banking capital, which could be a one-off. But, foreign investment—a more resilient pillar—has also been on a downtrend, coming at a three-quarter low in Q4. This was led by sharp foreign portfolio investment (FPI) outflows and limited foreign direct investment (FDI) inflows.
Meanwhile, the annual data shows that while FPI flows remain negative for the second consecutive year, net FDI inflows at $28 billion in FY23 was the lowest in the last nine years. There is some hope that FDI inflows may revive this year, aided by India’s promising growth prospects but subdued global economic outlook and uncertainty in financial markets pose downside risks.
To be sure, FPI inflows have rebounded, with net inflows being positive from March, as per NSDL data. In fact, this is a key factor driving India’s benchmark indices to new highs. On Wednesday, Nifty 50 index hit the psychological mark of 19,000 during trading hours. This also means valuations are now pricier and warrant some caution.
However, the outlook for FPI inflows in debt market looks uncertain, amid the possibility of a reducing interest rate differential between India and other large economies. This looks likely as Reserve Bank of India may hold rates steady, but key central banks such as Bank of England and European Central Bank are on a monetary tightening spree and US Federal Reserve may deliver two more rate hikes in 2023.
Thus, the capital account may face headwinds too, which is a dampener for the country’s external sector dynamics and currency trajectory. So far, the rupee has been relatively stable since the beginning of 2023 but a stable BoP surplus is vital for sustained strength, especially in an uncertain global economic backdrop and volatile financial markets.“Despite sound macro fundamentals, we expect the rupee to trade with a modest depreciation bias on global slowdown risks and election dynamics (due in CY24)," wrote Teresa John of Nirmal Bang Institutional Equities in a report on 28 June.
