After the worrying deterioration in its balance of payments in the first half of FY23, India has recorded a welcome pull-back in the third quarter. Latest RBI data show the Current Account Deficit (CAD) for October-December 2022 shrinking to 2.2 per cent of GDP ($18.2 billion), after widening to 3.7 per cent ($30.9 billion) in Q2. Financial flows comfortably covered this gap, resulting in a minor accretion to the foreign exchange reserves.
Economy watchers are generally wary of India’s current account gap exceeding 4 per cent, as they believe this poses challenges to dollar financing in a turbulent global market. The recent improvement has prompted analysts to cut their CAD predictions for FY23 from 4 per cent earlier to 2.5-3 per cent now, with some even hopeful of a surplus in future. Given the many moving parts to the current account balance, it is best not to count these chicken before they hatch.
The unexpected improvement in the current account balance for Q3 came from a lower goods trade deficit, coinciding with a record surplus from services trade. With recession fears haunting the West, exporters saw a marked slowdown in orders for everything from engineering goods to petroleum products. But the goods trade deficit narrowed despite this, because of sliding imports. The merchandise exports outlook remains clouded and the sharply lower imports of gold and commodities in Q3 may not sustain. Hence, there’s uncertainty about the goods trade deficit in coming months. Services exports offer more room for optimism. Despite global growth worries, services exports grew 24.5 per cent in Q3 to hit a record $83.4 billion, generating a trade surplus of $38.7 billion. Lately, the traction in services exports has come not just from IT services, but also from consulting, legal and professional services rendered by global capability centres that have sprung up in India since Covid. India’s services exports feature higher value-addition than merchandise exports and are less import-intensive. It is thus a positive that services have been improving their share in the export mix, growing by 67 per cent in the last five years and bringing in $240 billion in the first nine months of FY23 (compared to $340 billion goods exports).
On financing of the Q3 deficit, remittances from Indians abroad ($30.8 billion) and returning foreign portfolio flows ($4.6 billion) saved the day, even as direct investments ($2.1 billion) dried up. But if there is one wild card that policymakers need to watch out for, it is the US economy which appears quite precarious thanks to the Fed’s uncalibrated rate hikes and their impact on consumption, housing and jobs. The US is the largest destination for India’s merchandise exports (15 per cent share), while its BFSI companies are key clients for IT exporters. Trends in US jobs and incomes have a big role to play in financing India’s CAD, because the US has replaced West Asia in recent years as the primary source of NRI remittances.