Deceptive CAD

Nine-year-low hides many weaknesses

India’s current account deficit (CAD) may have hit a 36-quarter low in Q4FY16 and narrowed to near-zero compared with 1.3% in Q3FY16, but there is lots to worry about. In fact, most economists had expected a small current account surplus for the quarter given how oil imports have fallen, but weaker remittances and higher services imports prevented that. Merchandise imports have risen, especially non-gold, non-oil imports, which would suggest there is some recovery in industry. However, some of these could be related to the defence sector and may not be capital goods imported by companies for projects. HSBC economists point out in a report that merchandise imports during the quarter were much higher than reported in the customs’ data which does not capture defence-related imports. The share of invisibles in Q4FY16 was smaller, driven down by lower remittances and higher software-related imports. What is particularly worrying is that private transfers or remittances contributed $15.7 billion—falling just slightly when seen sequentially, but by nearly $2 billion when compared year-on-year. This is not totally unexpected since the collapse in crude oil prices has hurt economies in the Middle East—a big source for remittances—but nevertheless is some cause for concern. Also, net inflows into the capital account dropped off to just $3.5 billion compared with a more robust $10.9 billion in Q3FY16; while FDI inflows were reasonably good, portfolio inflows slowed as did banking capital.

For FY16, the CAD came in at 1.1% of GDP, a shade lower than the 1.3% of GDP in FY15. Given how global trade isn’t expected to grow meaningfully for a year at least, India’s exports in FY17 aren’t likely to clock in a growth of more than 4-4.5% over the $266.4 million earned last year. If the rupee depreciates more sharply than the currencies of competing countries—in the event of a Brexit and the ensuing turmoil—it may give exporters some edge, but not enough to boost their ear nings very significantly.

However, since the tab for both oil and gold isn’t expected to go up too much and no meaningful pick-up is expected in other imports either, the current account balance should not increase very dramatically. That is, unless private transfers fall sharply. As for the capital account—and the balance of payments—the swing factor would have to be portfolio investments which were negative last year, at just over minus $4 billion. India is expected to attract more portfolios this year, given the promise of good growth and the slowdown in China. But it would be perhaps safer to bet on more FDI; last year saw $36 billion come in, this year it could be better.