India’s Q3 FY24 current account deficit moderated to 1.2% of GDP (i.e., USD 10.5 bn) compared to 1.3% of GDP (i.e., USD 11.4 bn) in the previous quarter, and sizably lower vis-à-vis 2.0% of GDP (i.e., USD 16.8 bn) a year ago. Amidst the continued sequential improvement in net capital inflows in Q3, the Balance of Payments (BoP) surplus improved to 0.7% of GDP (i.e., USD 6.0 bn) from 0.3% of GDP (i.e., USD 2.5 bn) in Q2 FY24. 

Key granular highlights: 

From a sequential perspective –

• Merchandise trade deficit widened to USD 71.6 bn in Q3 from USD 64.5 bn in Q2 FY24. This was an outcome of a combination of exports registering a 1.5%QoQ contraction, while imports expanded by 3.2%QoQ.  
• Despite a weaker trade balance, CAD was contained due to a rise in net invisibles, that was led by both services and transfers.
  1. In value terms, services trade surplus recorded its fresh quarterly peak of USD 45.0 bn in Q3 compared to USD 40.0 bn in Q2 FY24. The gains were led by IT service exports along with support from other business services – both of which were at record quarterly highs yet again. 
  2. Net inflow under transfers rose to USD 29.3 bn in Q3 from USD 24.9 bn in Q2 

• On the capital account side, the surplus rose to 1.9% of GDP (i.e., USD 17.4 bn) in Q3 from 1.5% of GDP (i.e., USD 13.0 bn) in Q2 FY24. The revival in net inflows on the capital account was led by -
  1. Net FPI flows picked up to USD 12.0 bn in Q3 from USD 4.9 bn in Q2FY24
  2. FDI swung into a net inflow of USD 4.2 bn in Q3 from a net outflow of USD 0.3 bn in Q2 FY24.
  3. Banking capital rose to a 6-quarter high of USD 16.4 bn in Q3, from USD 4.3 bn in the previous quarter. 
  4. Weighing on capital flows were:
     • Loans registered its first net outflow in 13-quarters. This was on account of the fall in short-term trade credit as well as ECBs.
     • ‘Other Capital’ too witnessed a sizeable outflow. This could represent leads and lags in estimated export receipts, ADRs/GDRs/ECBs held abroad, advance payments against imports, etc.

On annualised basis, the narrowing of the Current Account Deficit has been single-handedly driven by improvement in net inflows on invisibles led by services; as trade deficit remained little changed. This was accompanied by a moderation in net capital inflows, led by sharp swing in ‘Other capital’ from inflow to outflows, which more than offset the upside in Foreign Portfolio inflows. 

Outlook

The dynamics on current and capital account continue to provide an overall sense of stability on India’s BoP, owing to - 

• Range bound moves in commodity prices, despite lingering geopolitical concerns. Amidst an anticipated slowdown in China, upside in global commodity prices could remain contained in 2024. 
• Support from services trade continues to remain intact, and is likely to continue well into FY25 given the resilience in US economy. 
• Monetary policy pivot by G3 central banks in the foreseeable future has helped step up equity portfolio flows in most emerging economies, including India. On a FYTD basis, India has received total FPI flows of USD 40.1 bn – with added support from debt flows, owing to the impending inclusion of India in EM bond indices. 

In addition, 

• For Q4, net exports are likely to pose a lower drag on Current Account Balance, as the quarter witnessed a faster growth in exports vis-à-vis imports for the first time in FY24. As such, amidst the consistent strength in services exports, Current Account Balance is likely to see a further improvement.  
• While recent momentum in FDI inflows appears subdued, it could potentially improve post the general election outcome in Q1 FY25.
• 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. 
• The adverse impact of spillover from ongoing disturbance in the Red Sea region is yet to manifest on India’s trade data. 
• While cost of freight container transportation has come off marginally over the last few weeks (see chart), but costs do continue to remain elevated compared to pre-Red Sea region tensions. The impact can be expected to filter through, manifesting as higher input costs if tensions continue to persist over the coming months. We will continue to watch the incoming data for the impact. 

Factoring in the above, our FY24 CAD and BoP forecast stand at USD 28 bn (0.8% of GDP) and USD 58 bn respectively. 

Commensurately, the forecast for FY25 current CAD and BoP stands at USD 38 bn (1.0% of GDP) and USD 52 bn respectively. The FY25 dynamics will be governed by – (i) Marginal upside in crude imports owing to continuing geopolitics tensions and lower discounts on Russian oil (ii) Gold imports remaining firm amidst elevated prices as key central banks approach rate cuts (iii) Non-oil Non-gold imports slowing as GVA growth moderates in FY25 (iv) merchandise exports faring marginally better, with added support from services exports 

Says Suman Chowdhury, Chief Economist and Head- Research, Acuité Ratings & Research “While the merchandise trade deficit has seen a sequential uptick, the CAD is expected to be better than expectations and anchor around 1.0% of GDP over the next one year due to the buoyancy in services exports and importantly, the rangebound movement in commodity prices. The foreign exchange reserves stood at a robust USD 642 bn as on the middle of March buoyed by the positive accretion to reserves aggregating to USD 32.9 bn in Apr-Dec’23. Nevertheless, we expect the INR to undergo a mild depreciation in FY25 given the likely delay and the relatively moderate rate cuts in the developed nations along with RBI’s active management of the currency to keep it reasonably anchored to the real effective exchange rate.”

Table 1: Key items within India’s BoP

Chart 1: Foreign investment flows are likely to find support from the impending inclusion of India in EM bond indices