Overview

India’s current account deficit narrowed to USD 18.2 bn (2.2% of GDP) in Q3 FY23 from USD 30.9 bn in Q2 FY23 (3.7% of GDP). The accompanying improvement in the capital account pushed the net balance of payments (BoP) position to register a surplus of USD 11.1 bn (1.3% of GDP) after reaching its weakest contraction level since the 2008 Global Financial Crisis of USD -30.4 bn (3.7% of GDP) in Q2 FY23.

Highlights of Q1 FY23 Data

·     The improvement in the current account balance was primarily due to an expansion of services trade surplus which scaled to a fresh record high of USD 54.5 bn in Q3 FY23 from USD 37.6 bn a year ago and USD 47.4 bn in Q2 FY23.

o    Uptick in invisibles was led by – 1) Improvement in Software exports aided by the traction towards digitization which continues to push demand for India’s IT exports that stood at a 56-quarter high of 4.6% of GDP in Q3 FY23; The growth in services exports is not only driven by the billings of the Indian IT service providers but also by the ITES/R&D centres set by the global corporations in India 2) Recovery in travel services registered a net inflow of USD 1.2 bn on account of reopening dynamics and festive demand, from a net outflow of USD 1.8 bn in Q2 FY23 3) Private transfers at USD 28.5 bn registered gains with net inflow of 3.4% of GDP, a 34-quarter high.

o    However, the deficit under income balance widened to a new record high of USD 12.7 bn in Q3 FY23 from USD 11.5 bn a year ago and 11.8 bn in Q2 FY23 due to higher outflows on account of accrued investment income.

·    Merchandise trade deficit narrowed to USD 72.7 bn (8.6% of GDP) in Q3 FY23 after reaching the highest level on record of USD 78.3 bn (9.5% of GDP) in Q2 FY23. This can be attributed to the softness in global commodity prices, along with the visible slowdown in global and domestic demand.

·     Capital account surplus widened to USD 30.2 bn in Q3 FY23 from USD 22.5 bn a year ago and USD 1.4 bn in Q2 FY23.

o     Improvement transpired despite quarterly moderation in portfolio investment to USD 4.6 bn from USD 6.5 bn in Q2 FY23. Sharp increase in banking capital to USD 14.4 bn in Q3 FY23, reflective of the buildup of foreign currency assets on banks’ balance sheets to cushion their capital position, helps in explaining the overall improvement in capital account. This was accompanied by rising loans to USD 1.8 bn on account of increase in external assistance to India.

o    However, net FDI inflows decreased sharply to the lowest level in last 10 quarters of USD 2.1 bn in Q3 FY23 compared to USD 6.2 bn in Q2 FY23.

Outlook

The simultaneous reduction in the current account deficit along with expansion of the capital account surplus seen in Q3 FY23, is comforting as it pushed the BOP position into a moderate surplus. This was driven by the moderation in global commodity prices, strength in services trade and transfer payments along with robust momentum in banking capital.

Looking ahead, we believe that the peak discomfort on BoP is well behind us -

• Moderation in global commodity prices in last 7-months has led to lowering of monthly merchandise trade deficit run-rate, averaging at USD 24.2 bn in Q3 FY23 down from USD 26.1 bn in Q2 FY23 (CMIE).

• Despite a hostile global environment, the outlook on services exports remains bright as they continue to scale new highs.

• The increased access to Russian crude oil appears to be playing a supportive role in containing trade deficit.

• With key central banks now gradually pivoting towards less aggressive rate hikes due to moderation in inflation, portfolio investor sentiment appears to be stabilizing.

However, amidst an uncertain geopolitical environment, concerns over the health of banks in the U.S. and Eurozone along with slowing global growth, we must continue to be mindful about the fragility of current account balance and capital flows. While improvements in the capital account are encouraging, the access to foreign currency debt may be a challenge in the near term given the banking crisis and the fairly rapid rise in global interest rates that will eventually reduce credit appetite.

Keeping in mind the Q1-Q3 FY23 BoP outcome, along with the moderation in crude oil prices, we now revise our forecast for FY23 current account deficit (CAD) to 2.0% of GDP (USD 68 bn) from 3.1% (USD 106 bn) earlier. From BoP perspective, we now anticipate the deficit to be lower at 0.5% of GDP (USD 17 bn) from 1.1% (USD 38 bn) earlier. For FY24, we expect current account deficit to be at 1.4% of GDP (USD 53 bn) and BoP to be marginally in surplus of 0.4% of GDP (USD 14 bn).

Says Suman Chowdhury, Chief Analytical Officer “Despite the challenges on the merchandise exports front amidst the ongoing global slowdown, India’s current account and BoP position has got tailwinds from lower commodity prices, higher share of Russian crude imports and buoyancy in services exports. This has helped in a moderate recovery in the foreign exchange reserve position which rose to USD 579 bn as in the thrid week of Mar-23. These tailwinds are expected to support the rupee in FY24 and we don’t expect any significant depreciation from the current levels. Nevertheless, the high level of turbulence in the global markets will keep the external risks alive, the latest being the supply cut announced by OPEC+.”

Table 1: Key items within India’s BoP

Chart 2: Current Account Deficit (CAD) sees an improvement