A common thread running through external sector documents released by the RBI on June 30 is the build-up of a higher-level foreign exchange reserves to the tune of $59.5 billion in 2019-20 as compared with negative reserves of $3.3 billion in the previous year. The accretion to reserves comes from a lower current account deficit and higher net capital flows. However, this number of $59.5 billion needs cautious analysis.

Under the capital flows during Q4, there has been a surge in “other capital receipts” to the tune of $13.8 billion. For the full year, the number was $18.4 billion as compared with $0.5 billion in 2018-19. This was on account of the uncertainties in investment climate due to Covid-19.

As a result, foreign portfolio investors (FPIs) have kept their investible funds with the custodian banks and FDI companies have not issued their shares (as per extant guidelines of the RBI, FDI companies can keep the share issuance pending for 90 days). The consequences of this is that our usable forex reserves could be lower by around $14 billion because we don’t know how many of these FPI and FDI will be pulled back.

Usable reserves

The usable reserves, thus, are worked out to be around $45 billion for 2019-20. This development has implications for external sector vulnerability indicators as outstanding usable reserves as on end-March 2020 will work out to $463.8 billion as against the printed figure of $477.8 billion. For example, total external debt to usable reserves works out now to 83 per cent as compared with 85.5 per cent and short-term debt of residual maturity to usable reserves work out to about 53 per cent as against the printed 49.5 per cent.

The uncertain investment climate due to continuation of Covid-19 will impact the reserve position in the near future also. Therefore, taking into account the pending issuance of shares by FDI companies and outstanding balances with the custodian banks by FPIs, as a future guidance, it will be appropriate the authorities may consider usable reserves rather than the “accrued” reserves.

What then is the outlook for external sector in 2020-21? Covid-19 has already adversely impacted the agility of India’s external sector in terms of substantial contraction in export and import and trade deficit as evident from the April-May trade data of the Ministry of Commerce. Illustratively, during the two months period of the current fiscal (April and May), exports declined by 47.54 per cent and imports declined by 54.67 per cent.

Thus, the trade deficit (the difference between goods imported and exported) during this period was $9.91 billion as against a deficit of $30.69 billion in April-May 2019. In a relative sense, imports have collapsed, reflecting the global recessionary tendencies because of Covid-19.

Estimating CAD

How do we estimate the CAD (current account deficit) and capital flows for 2020-21? Our assumptions are: (a) export growth will be in the range of (-) 45 per cent in Q1 and (+) 10 per cent in Q4; and (b) import growth will be in the range of (-) 50 per cent in Q1 and (+) 10 per cent in Q4. This is based on the assumption that negative growth both in export and import will be of broadly the same magnitude and will continue in Q1 and Q2, while the situation will improve in Q3 and Q4.

This assumption is further based on trends in the first two months of the current fiscal, and continuation of the same for Q2 as the lockdown continues. We expect there will be a pick-up in trade in Q3 and Q4 as the Covid situation eases and net pent up demand pushes economic activity.

Further, it is assumed that oil import and export will be a shade lower than 2018-19. Thus, the trade deficit in 2020-21 works out to $110 billion as compared with around $158 billion in 2019-20. We assumed net traditional services like travel, transport and insurances will be near zero but there could be some net receipts in case of modern commercial services like software services, engineering services, consulting services. Thus, we assumed net services at $75 billion as against $85 billion in 2019-20.

In the income account, we estimated primary income lower at (-) $20 billion in 2020-21 than that of (-) $27 billion in the previous year based on a decline of around 25 per cent in the investment income and business and travel restrictions leading to a lower compensation to employees. A 25 per cent decline is being seen as a conservative number by analysts.

Secondary income, mainly comprising workers’ remittances, will be lower by an estimated 10-15 per cent in the view of analysts. This means the secondary income will be around $65 billion in 2020-21 as against $75 billion in 2019-20. This development is mainly on account of international migrant workers who are coming back to India and possibility of lower income due to recession.

In the end, the current account balance [comprising (a) trade deficit of $110 billion plus (b) net services at $75 billion, (c) net primary income at (-) $20 billion and (d) net secondary income of (+) $65 billion)] works out to a surplus of around $10 billion or 0.4 per cent of GDP.

It may be mentioned that the surplus in the current account was last recorded 17 years back in 2003-04 aggregating $14.1 billion or 2.3 per cent of GDP. This year, we will have a surplus gain essentially because of lower trade deficit in the light of Covid-19.

Capital inflows

Due to uncertainties in the investment climate because of Covid, capital inflows will be erratic particularly in respect of foreign portfolio investment. However, the liquidity injection by many foreign central banks in recent times may encourage portfolio investment both in equity and debt guided by arbitrage opportunities in terms of higher interest rates in India. But there will be slowdown in the inflows from FDI and ECB due to global recession and recession in India. Uncertainty in net capital inflows could have episodes of volatility in exchange rate. The “hot money” in terms of FPI will be a matter of concern in terms of external sector vulnerability.

What all this tells us is that the external sector will pose some unique challenges of the kind we have not seen in many years. Numbers that look robust could prove to be, at least in part, a mirage. A collapsed trade scenario will bring a new kind of challenge. This will require deft handling and dynamic adjustments to the evolving scenario.

Through The Billion Press. The writer is a former central banker and a faculty member at SPJIMR. Views are personal