India’s Current Account Deficit (CAD) came in at USD 8.3 bn (1.0% of GDP) in Q2 FY24. This marked an improvement that was marginal when compared to USD 9.2 bn (1.1% of GDP) in Q1 FY24, but substantial vis-à-vis USD 30.9 bn (3.8% of GDP) a year ago in Q2 FY23. With capital inflows on the wane in Q2 FY24 vis-a-vis the previous quarter, Balance of Payments (BoP) surplus fell sharply to USD 2.5 bn in Q2 FY24 from USD 24.4 bn in Q1 FY24.

Granular Highlights: 

From a sequential perspective: 

• Merchandise trade deficit widened to USD 61.0 bn in Q2 FY24 from USD 56.6 bn in Q1 FY24. For the three months on a cumulative basis, exports had registered an expansion of 3.3%QoQ, only to be outpaced by sequential growth in imports by 4.9%.
• Despite a weaker trade balance, CAD was contained due to a rise in net invisibles, that was led by both services and transfers.

o   In value terms, services trade surplus recorded its fresh quarterly peak of USD 40.0 bn in Q2 FY24 compared to USD 35.1 bn in Q1 FY24. The gains were led by IT service exports along with support from other business services – both of which were at record quarterly highs despite the global slowdown and lower IT spending.

o   Net inflow under transfers also rose to USD 25.0 bn in Q2 FY24 from USD 22.9 bn in Q1 FY24.

• On the capital account side, the surplus contracted sharply to USD 10.0 bn in Q2 FY24 from USD 34.4 bn in Q1 FY24. The pressure on the capital account was broad based with: 

o   Net FPI flows dropping to USD 4.9 bn in Q2FY24 against a robust USD 15.7 bn in the previous quarter

o   Net FDI recording an outflow of USD 0.3 bn in Q2 FY24 for the first time since the initial Covid shock in Q1 FY21.

o   In addition, commercial borrowings recorded net outflows at USD 2.9 bn in Q2FY24 (compared to inflows of USD 5.7 bn in Q1) while net inflows on banking capital moderated to USD 4.3 bn from USD 12.9 bn in Q1FY24.

o   The rise in US yields in the quarter and the strength in US Dollar possibly weighed on net inflows in the quarter, along with unprecedented geopolitical uncertainty. 

On annualised basis, Q2 FY24 marked the third consecutive quarter of a sharp correction in the CAD. This was driven by a lower trade deficit (amidst correction in commodity prices) alongside an improvement in net inflows on invisibles, i.e., predominantly in services. This accompanied by increase in net capital flows, led by swing in Banking capital from a deficit to a surplus, led the BoP to swing from a deep deficit of USD 30.4 bn a year ago to a surplus of USD 2.5 bn as of Q2 FY24. 

Outlook

Compared to a year ago, the overall dynamics on current and capital account both are lending a sense of comfort for India, amidst -

• Range bound moves in commodity prices. After some firm up in Q2 FY24, global commodity prices have broadly moderated in Q3 FY24, especially crude oil despite lingering geopolitical disturbances. Amidst concerns of slowing global growth momentum heading into 2024, commodity price pressures could remain somewhat contained. 
• Support from services trade continues to remain intact and is likely to continue up to the end of FY24. Thereafter, some downward pressure can be anticipated, amidst slowing pace of economic activity in developed economies, especially US. 
• The much-anticipated rate pivot from US Federal Reserve has helped step up portfolio flows in most emerging economies. Post the Dec-23 policy, market participants are expecting the first rate cut from Fed to come in as early as Mar-24. India too has been a benefactor, with net portfolio flows in Dec-23 clocking at USD 8.9 bn, so far (as on Dec 27, 2023)  – the highest monthly pace in 36-months. The results of domestic state elections, reinforcing support for the BJP at the Central Government level ahead of national elections early next year, has further aided the moderation in domestic political uncertainty. 
• In addition, the commencement of front-running by market participants for India’s inclusion in JPM’s EM Bond Index from Jun-24 onwards too is likely to play a supportive role. 

Says Suman Chowdhury, Chief Economist and Head – Research, Acuité Ratings & Research “Our near term outlook on the CAD and BoP has improved over the last month and this is primarily due to two fundamental factors – one, the resilience in the CAD accruing from services and invisibles flows notwithstanding the pressures on the merchandise trade deficit and second, the expectations in the global markets of an early pivot by Fed which is driving higher capital flows into India apart from the JPM bond index inclusion factor. The cumulative net FPI flows in Nov-Dec has been around USD 12 bn as compared to -USD 3.8 bn in the previous two months. We now believe that there is a downside risk to our FY24 CAD estimate of USD 67 bn, which in turn could manifest via a somewhat higher than projected BoP surplus of USD 32 bn. While the INR has remained volatile and saw a new low of 83.43 in early Dec-23 against the dollar, we expect it to strengthen moderately in the next few months. ”  

Table 1: Key items within India’s BoP