By Aastha Gudwani
India’s economic position is expected to be in a much better state than in 2013, anchored by contained CAD, surplus BoP, record-high FX reserves, comfortable import cover and lower external debt ratio.
Given the sharp increase in global commodity prices, particularly oil, concerns around India’s current account deficit (CAD) and its serviceability have resurfaced. Potential Fed taper has only added to these jitters. We see FY22 CAD at 1.3% of GDP, well contained within the 2.5% of GDP threshold. Capital account surplus in FY22 is expected to be better than in FY21, resulting in a BoP surplus of $53bn.
We assess India’s external position to be in a much better state than in 2013, anchored by the contained CAD, surplus BoP, record-high FX reserves, comfortable import cover and lower external debt ratio. This should help insulate the Indian markets from a potential Fed taper, unlike the 2013 tantrum.
BoP: Strong start to FY22, but peak behind us
June quarter current account balance surprised with the larger-than-expected surplus of $6.5bn (0.9% of GDP). Capital account saw robust inflows of $25.8bn, led by solid FDI flows even as FPI flows were sharply lower. Banking & other capital also swung to an inflow in the June quarter after registering outflows in the March quarter. Accordingly, the BoP surplus for the June quarter rose sharply to $31.9bn.
Despite this solid start to FY22, we believe the peak BoP surplus is behind us. Going forward, we expect the trade deficit (& therefore CAD) to rise sharply as domestic demand continues to recover. Imports are also expected to rise due to higher global prices, particularly oil.
In the case of the capital account, while FPI inflows are expected to moderate given already rich equity market valuations and expectation of policy normalization by the RBI could keep debt inflows at bay, net FDI inflows are expected to stay robust. Apart from these- banking capital, loans and other capital – are expected to improve vs FY21.
Trade deficit to rise on reopening and higher global commodity prices
The goods trade deficit has totalled $78.4bn in 1HFY22, up to $52bn from the same period last year, as imports jumped 82% YoY vs. the 58% gains in exports. Given a favourable base, despite localized lockdowns, all categories of imports have registered strong growth in H1 FY22 with re-opening picking up pace and latent demand coming to the fore.
The jump in the import bill reflects not just demand improvement, but also rising global commodity prices, especially for oil. The 82% YoY increase over Apr-Aug 2022 is largely explained by the near-doubling of global oil prices during this period, while import volumes are up only 14.5%. Meanwhile, on the gold front, import volume has started to rise while prices have fallen, with the law of demand kicking in.
On the exports side, engineering goods, which consists of various items such as iron & steel, auto components, industrial & electrical machinery, form the largest share at 27% of total exports. This segment is up 68% YoY over Apr-Aug and should continue to be supported by recovering global demand. Lastly, despite an uncertain domestic and global environment since the start of the pandemic, India’s services net exports have been remarkably resilient. Led by software services exports, total services net exports clocked in a monthly run rate of $7.5bn over the past 18 months, even better than 2019 levels.
Capital account: Supported by ‘other’ flows
Capital account surplus is expected to improve in FY22, despite an estimated fall in portfolio inflows amidst steady FDI. After a stellar FY21, where foreign portfolio inflows totalled $36bn, both equity and debt inflows have lost momentum in FY22. In fact, the outlook isn’t too encouraging either, with rich market valuations putting off more equity inflows on the one hand and expectations of policy normalization acting as a headwind to debt flow on the other.
On the FDI front, we expect the upbeat momentum to continue well into FY22. While portfolio flows are expected to decline and FDI steady, the remaining sub-components of the capital account are showing signs of a big turnaround.
Adding it all together, the BoP surplus is expected to moderate to $53bn in FY22 from $87bn in FY21.
External vulnerability: Ready for taper without tantrum
With the US Fed prepping for a taper, the painful memories of 2013 are likely to come flashing back. We think the impact of the Fed taper on India should be more muted this time. India was widely considered to be amongst the ‘fragile five’ EM economies back in 2013. The current account deficit was running at a high 4.8% of GDP, and import cover was a low 7 months with FX reserves of $300bn.
Unlike then, today, India is in a much stronger external position – with FY22 CAD estimated at a contained 1.3% of GDP and RBI’s FX reserve arsenal at a record high of $640bn. This provides enough cover worth 13 months of imports. In fact, FX reserves as % of GDP stand tall at 22% of GDP now vs. 15% back in 2013.
India’s external debt position is also much stronger now, external debt as % of GDP has moderated from 22.4% as of Mar-2013 to 20.2% as of Jun-2021. However, short-term debt (on residual maturity basis) has risen as a share of total debt from 42.1% in Mar-2013 to 44.7% as of Jun-2021. Nevertheless, given that overall external debt is well within manageable limits, we are not too worried by the slight deterioration on the short-term debt front.
With India’s external position in a significantly better shape than in 2013, the potential Fed taper is unlikely to exert serious & sustained pressure on the INR. A contained current account deficit of just over 1% of GDP and overall BoP surplus on one hand, and record-high FX reserves and comfortable import cover on the other should provide solid protection for the INR.
(Aastha Gudwani is an economist with over a decade’s experience covering India macro economy.)
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