India’s current account deficit narrowed marginally to 1.2% of GDP (USD 11.2 bn) in Q2 FY25 from 1.3% in Q2 FY24 (USD 11.3 bn). Total capital flows swelled to a 5-quarter high of 3.3% of GDP (USD 30.5 bn) during Q2 FY25 vis-à-vis 1.5% (USD 12.8 bn) in the corresponding quarter of FY24. As such, the net balance of payment recorded a surplus position of 2.0% of GDP (USD 18.6 bn) in Q2 FY25, up sharply from 0.3% (USD 2.5 bn) in Q2 FY24. 

Key granular highlights 

• The merchandise trade deficit widened to a 7-quarter high of 8.2% of GDP in Q2 FY25. This was on account of subdued performance by exports, which, as a ratio to GDP, slipped to 11.4%, the lowest in 15 quarters. In contrast, the ratio of merchandise imports to GDP stood at a 3-quarter high of 19.6% in Q2 FY25. From a commodity perspective, the widening of the headline deficit was led by precious metals (esp. higher import of gold post the duty relief provided in the FY25 Union Budget presented in Jul-24) and electronic items (possibly reflecting a buildup of inventories ahead of the festive season demand).
• The impact of a wider merchandise trade deficit was completely neutralized by higher invisible receipts that sprung to 7.0% of GDP in Q2 FY25. 
  1. The services trade balance maintained its sturdiness by printing at 4.9% of GDP. This was supported by services exports that set a record high of 10.2% of GDP in Q2 FY25. Notably, software exports clocked their highest-ever net dollar revenue of USD 39.6 bn, and the share of the business and financial services in the net services trade balance rose to 23.7%, its highest ever.
  2. Transfers (reflecting remittances by Indians employed overseas) also improved to 3.2% of GDP in Q2 FY25 from 2.9% in the corresponding quarter of FY24.
  3. Last but not least, the income account deficit moderated to 1.0% of GDP in Q2 FY25, its narrowest in 18 quarters. Interest earnings from the RBI’s record-high FX Reserves held during the quarter appear to have provided support.
• On the capital account front, the notable highlights were: 
  1. The slippage of net direct investment flows into negative territory. At -0.2% of GDP, Net FDI flow is the weakest in the last 74 quarters. This reflects higher repatriation/disinvestment outflows by MNCs/VCs/PEs rather than any sharp slowdown in the gross inward FDI flow.
  2. FPI flow recovered sharply to 2.2% of GDP in Q2 FY25, supported by both equity and debt purchases by foreign portfolio investors. India’s relatively stable macros had helped to attract FPI interest in the backdrop of slowdown concerns in China and investor expectations moving towards initiation of monetary policy easing by the US Fed. 
  3. Led by ECBs raised by domestic corporates, debt flows on account of external loans improved to 0.8% of GDP in Q2 FY25 from 0.4% in the corresponding quarter of FY24.

Outlook

India’s current and capital accounts, along with the overall BoP, depicted a reasonable degree of health during H1 FY25. Having said that, the drivers for BoP have undergone sharp changes since Oct-24, thereby giving rise to near-term pressure points for the Indian rupee.

On the CAD front, the merchandise trade deficit is facing sizeable pressure from a step-up in the import of precious metals* (reflecting the cumulative impact of the reduction in customs duties, record high international prices, and hedging-related demand). Although merchandise exports have recovered somewhat in recent months, the outlook does not inspire confidence on account of likely disruption to global merchandise trade from the imposition of tariffs under the Trump 2.0 regime beginning Jan-25.

On the capital flows front, we believe foreign investment flows could face high volatility on account of an uncertain geopolitical and geoeconomic backdrop. The swing factors to watch for would be the direction of overall economic policy (trade, labour, domestic manufacturing) in the US, implications on the Fed’s monetary policy trajectory, and spillover impact on global commodity prices and the Chinese economy in particular. In addition, the recent hardening of US interest rates is also likely to weigh upon external loans, like the ECBs.

The silver lining we see as of now is the prevailing strength in the services trade surplus, which in recent quarters has been able to offset as much as two-thirds of the merchandise trade deficit. However, this element of strength could potentially face some pressure over the medium term if laws related to work visas in the US are tightened, thereby having some adverse impact on India’s software receipts.

Taking the above factors into account, we now attach a mild upside risk to our FY25 CAD estimate of 1.2% of GDP (USD 45 bn). At the same time, with capital flows coming under pressure, our FY25 BoP surplus forecast of USD 35 bn faces considerable downside risk. We are awaiting clarity on the extent of correction in the import figures for precious metals to freeze our revised estimates on CAD and the BoP.

With BoP coming under pressure, INR has already breached our Mar-25 target of 85.50. Since uncertainty in the near term is likely to persist, we see little resistance for INR to move towards 86.00 in Q4 FY25.

* Import of precious metals jumped to USD 45.5 bn during Aug-Nov 2024 compared to USD 29.7 bn in the corresponding period in 2023. While this partly reflects demand-supply dynamics, as per recent media reports, the imputation of precious metals imported since Aug-24 could have suffered from an accounting error. Official clarity and corrigendum is meanwhile awaited.

Says Suman Chowdhury, Chief Economist and Executive Director, Acuité Ratings & Research “The stability of the INR have been challenged by the new normal in the global landscape, marked by the incoming new US administration, risks of a global tariff war, stronger than expected US economy and lower than expected rate cuts by Fed in 2025 (confirmed in the latest Fed meeting). All these have translated to capital outflows from emerging economies and a resurgence of the US dollar. Additionally, India’s trade deficits have also been higher than expected due to the surge in gold imports (albeit there is some confusion on the data) and a lack of consistency in the export trajectory.

While the INR has seen relatively less depreciation in the current calendar year compared to most other currencies, it has been actively supported by RBI’s intervention in the market, which has also led to a decline in the central bank’s forex reserves in the last 3 months. While our forecasts on CAD stands at 1.2% for FY25 and of INR at 85.5 as in Mar-25 end, there are visible downside risks.

Calendar 2025 can be a real test not only for India's external resilience but also for RBI's monetary policy decisions.”  

Chart1: Invisibles, led by services surplus, has been offsetting the pressure from the merchandise trade deficit

Table 1: Key items within India’s BoP