Overview

India’s current account balance for Q2 FY22 sharply swung into deficit of USD 9.6 bn or 1.3% of GDP after posting a surplus of USD 6.5 bn in Q1 FY22. The swing was due to a significant expansion of the trade deficit with a sharp jump in oil and gold imports recorded in the quarter. Despite that, BoP surplus remained little changed at USD 31.2 bn vs. 31.9 in Q1 FY22, as capital inflows witnessed a sharp jump driven by SDR allocation. We now revise up our FY22 current account deficit forecast to USD 46 bn from USD 38 bn earlier (from a surplus of USD 24 bn in FY21).

Trade deficit expands to the highest level in 9 quarters

• Higher jump in imports in Q2 FY22 vis-à-vis exports, led the trade deficit to widen sharply to USD 44.4 bn from USD 30.7 bn in Q1 FY22. This marked the highest trade deficit in 9 quarters and reflected an accelerated pace of normalization post the second pandemic wave.
• As per monthly trade data, the rise in imports was broad based, but primarily led by oil and gold imports.
• Net invisibles moderated to USD 34.8 bn vs. USD 37.2 bn in Q1 FY22. While net inflows on services and transfers remained little changed versus Q1 FY22, the downside was led by net overseas investment income payment (increased to USD 9.7 bn from USD 7.5 bn in Q1)

Capital inflows led by "Other capital” and Loans

• Net capital inflows rose to USD 40.1 bn in Q2 FY22 from USD 25.5 bn in Q1.
• However, the primary driver was increase in the "Other capital” component which rose to USD 18.8 bn from USD 6.6 bn in Q1, reflecting the USD 17.9 bn of SDR allocation from the IMF.
• Adjusting for this, net capital flows stand at USD 22.2 bn in Q2 – comparable to Q1 FY22 level.
• Among other sub-categories, net FDI inflows moderated to USD 9.5 bn from USD 11.7 bn in Q1, while net portfolio inflows improved to USD 3.9 bn from USD 0.4 bn in Q1 FY22 primarily led by debt inflows.
• Reflecting pickup in capital goods imports, inflows under loans increased to USD 7.6 bn in Q2 from USD 2.8 bn in Q1 FY22.

Outlook

The current account balance posting a deficit in Q2 FY22 was along expected lines although the extent of the deficit has been higher than expectations. The unlocking of the economy which allowed a strong sequential improvement in economic activity to take shape in Q2 FY22, in support from pent-up demand and higher commodity prices drove the surge in imports. With an accentuation of these factors, Q3 FY22 is expected to see a further expansion of the merchandise trade deficit. As per monthly trade data, cumulative trade deficit for months of Oct-21 and Nov-21 already stands at USD 42.6 bn – only a tad below Q2 FY22 level. Having said so, trade deficit in Q4 FY22 may somewhat narrow on account of reimposition of state level restrictions amidst the spread of infections owing to Omicron variant along with some year-end seasonality coming into play (export demand could get impacted too amidst the surge in global cases).

On capital account, Q3 FY22 has already seen a surge in FPI outflows to the extent of USD 6.5 bn, which could continue into Q4 FY22 as key global central banks begin to normalize monetary policy amidst enduring inflation at elevated levels.

Keeping in mind these dynamics at play, we revise up our FY22 current account deficit forecast higher to USD 46 bn from USD 38 bn earlier (from a surplus of USD 24 bn in FY21). As such, the FY22 BoP surplus projection now stands adjusted lower to USD 32 bn from USD 50 bn (after adjusting for the USD 17.9 bn worth SDR allocation from the IMF).

Table 1: Key items within India’s BoP