India’s current account balance swung into a surplus in Q1 FY22, clocking USD 6.5 bn (0.9% of GDP) compared to a deficit in previous two quarters. While the surplus was largely anticipated, the strength of the surplus did surprise us and markets positively. On the other hand, the net balance of payments rose to USD 31.9 bn in Q1 from a meagre USD 3.4 in Q4 FY21, and also faring stronger than USD 19.8 in Q1 FY21.

Current account dynamics

• The sequential improvement in current account surplus was on account of narrowing of the merchandise trade deficit amidst the second wave of the pandemic. While exports remained buoyant (as continued operations of the manufacturing sector and global growth aided), imports took a breather as lockdowns at the state level over Apr-May-21 weighed on discretionary demand especially for Gold.
• In added support, invisibles surplus rose from USD 33.6 bn in Q4FY21 to a record high of USD 37.2 bn in Q1 FY22. The upside in services has been led by improved surplus in software and business services, reflecting perhaps the positive impact of increasing digitisation in a post Covid business environment.
• Interestingly, gold imports in Aug-21 surged to a 5-month high at USD 6.7 billion amidst demand recovery and a recent moderation in gold prices, leading to a significant build-up in inventories ahead of the festive season. The cumulative gold imports in Apr-Aug’21 stands at a record high level of USD 18.8 bn, 30% higher than that in the pre-pandemic period (Apr-Aug’19). Higher imports of gold will be a factor in increasing the current account deficit in Q2FY22 and thereafter.

Capital account and Balance of Payments

• Net capital flows nearly doubled to USD 25.8 bn in Q1 FY22 from USD 12.3 bn in Q4 FY21.
• The improvement on the capital account was led by Foreign direct inflows (FDI), which stood at USD 11.2 bn in Q1 FY22, a sharp uptick compared to USD 2.7 bn in Q4 FY21.
• Foreign portfolio inflows (FPI)on a net basis, however sobered down to a paltry USD 0.4 bn in Q1 FY22 from USD 7.3 bn in Q4 FY21.
• Other forms of capital inflows, viz. external commercial borrowings and banking capital continued to provide support.
• On net basis, the BoP registered a strong surplus of USD 31.9 bn (4.6% of GDP) in Q1 FY22 compared to USD 3.4 bn in Q4 FY21.

Outlook

The second wave of Covid infections has led to a temporary surplus on the current account in Q1 FY22, which is likely to revert to a deficit Q2 onwards. The normalization in economic activity as lockdown restrictions ease and vaccinations gather steam, is already leading to a pick-up in import demand, in turn weighing on the trade balance.

• The monthly trade deficit after bottoming out at USD 9.4 bn has increased to USD 11.0 bn and USD 13.4 bn over the months of Jul-21 and Aug-21 respectively and further to USD 22.9 bn as per preliminary estimates of Sep-21.
• India has currently vaccinated almost 50% of its population with a single dose and we expect this coverage to increase towards 65-70% before the end of 2021.
• Looking ahead, the upcoming festivities along with progress in vaccinations is likely to propel domestic consumption demand, translating to a further normalization of the trade deficit and thereby overall current account.

Taking on board the impact of elevated commodity prices, we expect current account to post a moderate deficit of USD 30 bn in FY22 vis-à-vis a surplus of USD 24 bn in FY21. On the BoP front, we now see scope of an upward revision to our current FY22 call of USD 44 bn (vs. USD 87 bn in FY21) given the strong surplus posted in Q1 FY22. While we do anticipate foreign portfolio flows to be subdued as Federal Reserve begins to taper its asset purchases; the underlying strength in BoP could help insulate INR from excessive global FX volatility.

Annexure-1

Table1:Key items within India’s BoP