India’s merchandise deficit perceptibly narrowed to an 8-month low of USD 6.3 bn in May-21 from USD 15.1 bn in Apr-21. The moderation in trade deficit was led by a sequential increase in exports (+5.4% MoM) along with a significant sequential decline in imports (-15.7% MoM). We had already highlighted in our May-21 edition of "Acuite Macro Pulse” about the possibility of a sharp compression in May-21 trade deficit on account of state level lockdowns getting pervasive even as India’s key export partners progressively relaxed lockdown restrictions in their respective countries.

Looking at the drivers of trade deficit in May-21, we find that:

Exports: Remain healthy

In value terms, exports improved moderately to USD 32.3 bn in May-21 (+69.4% YoY due to the sheer base effect) from USD 30.6 bn in Apr-21. At a granular level:

• The sequential increase was led by a strong pickup in exports of Petroleum Products and Engineering Goods. On the other hand, there was a minor sequential drop seen in case of exports of Gems & Jewellery, Agriculture & Allied Products, and Textiles.
• Core exports (headline ex petroleum and gems & jewellery) stood at USD 24.0 bn in May-21, slightly up from USD 23.6 bn in Apr-21. While favorable base rendered a robust annualized growth of 46.5% in case of core exports, we note that export growth looks comforting at 12.7% even when compared to 2-year ago (May-19) levels. While the state level lockdowns became pervasive as well as stringent in May-21, its impact on overall exports appears to have been limited since most of the manufacturing units were allowed to operate with moderate restrictions.

Imports: Disruption from Covid

Merchandise imports slipped to a 6-month low of USD 38.6 bn in May-21 (+73.6% YoY) from USD 45.7 bn in Apr-21. At a granular level:

• Bulk of the sequential moderation was driven by a sharp decline in imports of gold to the extent of 89% in May-21. The combination of previous restocking (to take advantage of lower prices in Mar-21) and state level lockdowns amidst sharp resurgence in Covid infections seems to have weighed on demand for gold imports.
• The decline in headline imports was further led by Petroleum Products that saw a month-over-month drop of USD 1.4 bn in May-21. This is likely to be a manifestation of fall in petroleum consumption on account of state level lockdowns having a restrictive impact on mobility and economic activity.
• Overall, core imports (headline ex petroleum and gems & jewellery) actually remained static at around USD 26.2 bn in May-21 (USD 26.1 bn in Apr-21. Core imports appear to have held up well (46.0% YoY) despite the Covid related disruption in May-21. However, compared to its 2-year ago levels in May-19, core imports stand lower, with a contraction of 4.6%. This reflects subdued domestic demand over the course of last two years.

Outlook

There are two key trends critical for India’s trade deficit. In the near term, the overhang of Covid disruption could potentially persist for another month with Jun-21 trade deficit printing at moderate levels (could be around USD 11-12 bn, but wider on account of gradual relaxation in state level lockdowns, especially in the second half of Jun-21). This will ensure that India’s Q1 FY22 current account balance switches to a moderate surplus, like Q1 FY21, albeit to a much lesser degree.

However, the current account surplus is unlikely to sustain as global commodity prices have hardened considerably in last two quarters, to above pre Covid levels in most cases. More importantly, with the second wave ebbing, states have started to taper their lockdown stringency. This should once again start supporting overall economic activity, which would further get a boost from anticipated ramp up in domestic vaccination drive in the coming months. Hence, we continue to stick to our FY22 current account estimate of approximately USD 30 bn deficit vis-à-vis USD 26 bn estimate in FY21.

Table 1: Key items within merchandise trade balance

Chart 1: Global commodity prices have seen a sharp run up in last 2-quarters