With the rupee’s consistent slide this year, the focus is once again on the external account and the manner in which it is weighing on the Indian currency.
The country’s balance of payments (BoP) has always been a cause of worry for policy-makers, as higher imports and sluggish growth in exports have resulted in sustained current account deficit (CAD) for more than a decade, starting FY2005. But thanks to capital inflows in the form of foreign portfolio and foreign direct investment flows, the overall BoP has managed to remain in surplus.
But the country has been dealing with the dual impact of surging imports due to higher crude prices and decline in capital flows due to tightening liquidity conditions overseas. This has resulted in the country’s BoP turning deficit in the first quarter of the current fiscal year. Experts believe that there could be a deficit in BoP for the full fiscal year of 2019 too. The most recent BoP deficit was in FY12, caused by merchandise trade deficit and a sharp slowdown in FPI flows.
Interestingly, BoP deficit in a fiscal year has, invariably, been accompanied by a very weak rupee. Over the past decade, there has been two instances of a BoP deficit — in FY09 and FY12. The rupee depreciated 20.9 and 12.4 per cent against the dollar in these fiscals respectively. A similar scenario may play out this year as well.
Here’s a closer look at some of the significant components of the external account to understand how they can unfold.
Widening trade deficit
BoP captures all the transactions a country does with other countries. The current account segment of BoP pertains mainly to trade in goods and services (exports and imports). Long-term transactions such as FDI and FPI flows, and external debt fall under the capital account segment. The major pain-point in BoP has been the sustained merchandise trade deficit over the years.
The trade deficit of $45 billion recorded in the first quarter of the current fiscal has been the highest over the past five years.
This deficit has been caused by a strong surge in crude oil prices. Oil accounts for about 27 per cent of the overall merchandise imports. A strong rally in crude oil prices saw oil imports surge 25 per cent in FY18 to $109 billion compared with the year-ago period.
Oil prices, which have risen sharply in recent months, could remain elevated due to expected squeeze on supplies from Iran — a fallout of the US sanctions on the country. The sanction comes to effect from November. Whether supplies from other major oil producers such as Saudi Arabia can make up for this shortfall needs to be seen. If yes, the pressure on oil prices could ease.
The US Energy Information Administration expects global demand to exceed supply by 0.84 million barrels per day (bpd) in 2018 and 0.43 million bpd in 2019. Brent Crude prices are expected to average about $73 per barrel this calendar year and $74 per barrel in 2019, from the current rate of $78 per barrel.
Higher oil prices are likely to further increase India’s import bill. The country’s oil bill stands at $47 billion as of July, for the current fiscal. At this rate, oil import cost can increase 30 per cent (year-on-year) in FY19 to $141 billion.
Apart from oil, other commodities such as electronic goods, machineries and coal imports are also weighing on India’s trade deficit.
Invisibles pick up, but slowly
The second major component of the current account is the trade in invisibles. Service exports and imports, and official and private money transfers form a major part of invisibles. Invisibles have picked up in FY18 after having fallen over the previous two fiscals. Software services and private money transfers contribute the most to the invisibles.
The improving growth prospects of the US is expected to aid software exports. According to the International Monetary Fund, the US is projected to grow at a much faster pace of 2.8 per cent in 2018 compared with the 2.4 per cent in 2017.
While the surge in oil prices is a negative for the merchandise trade balance, it is a positive when it comes to private transfers. This is so because increase in oil prices help Gulf Cooperation Council (GCC) countries such as Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the UAE, where most of the NRIs reside. A major chunk of NRI remittances come from these countries. The IMF expects the GCC countries to grow at 1.9 per cent in 2018 and 2.6 per cent in 2019. This will help private transfers improve further this fiscal.
However, since the surge in trade deficit is likely to be higher due to increasing oil prices, the improvement in the invisibles may not be sufficient to bridge the gap in the current account.
CAD to widen
The consensus expectation that the trade deficit could increase 30 per cent to $141 billion in FY19, will widen CAD, too. India’s CAD more-than-tripled in FY18 to around $49, from around $15 billion in FY17. Experts believe that this number can worsen further to $70-80 billion in FY19. This amounts to 2.7-2.9 per cent of the country’s GDP.
The country’s CAD as a percentage of GDP hit the highest of 4.7 per cent in FY13 and improved to 0.6 per cent by FY17 as CAD narrowed from around $88 billion to $15 billion over the same period. Government measures to curb gold imports aided the narrowing of the deficit.
The forecast for FY19 is relatively better compared with the situation that prevailed in FY13. However, experts say that CAD at 3 per cent of GDP is the last straw and anything beyond that could cause jitters in the market and severely stress the economy.
The Centre recently announced that measures will be taken to curb imports of non-essential commodities. Also, there are expectations in the market that the government would hike import duty on gold as it had in 2013. But gold imports have stabilised at $28-$35 billion over the past few years after peaking to $56 billion in FY12. So, whether the curbs would help check CAD remains debatable.
Impact on rupee
Against this backdrop, controlling CAD appears a daunting task. Oil prices are likely to remain higher and invisibles are less likely to bridge the gap in the current account.
There isn’t too much comfort in the capital account, either (See box ‘Portfolio outflows roil capital account’). Tightening global liquidity is moderating FDI inflows into the country, while foreign portfolio investors are on the back foot due to rising global risk aversion. Overall, there is likely to be minimal surplus in the capital account in FY19, which will be insufficient to bridge the deficit in the current account.
Therefore, there is a high probability of BoP slipping into a deficit this fiscal, after a period six years. Experts think the rupee can weaken further, breaking below 73 in the short term, and then possibly recover to settle between 72 and 73 against the US dollar by March 2019.
- Capital account, the second segment in balance of payments (BoP), records the public and private investments coming into and going out of a country, reflecting changes in the ownership of foreign assets.
- Although total foreign investment flows — the sum of FDI and FPI flows — have been growing at a stronger rate over the past couple of fiscal years, the individual components are raising slight concerns.
- Net FDI flows recorded an increase of 51 per cent in FY15 over the previous fiscal, and 10 per cent in FY16. But FDI flows declined to $35.6 billion and $30.3 billion in FY17 and FY18, respectively. However, this was part of a wider global trend. Data from the United Nations Conference on Trade And Development show that the world’s total inflow from FDI was down 2.8 and 2.3 per cent in calendar years 2017 and 2018, respectively.
- It is apparent that the world is moving from an era of easy liquidity — helped by central banks pumping money to stimulate economies, post the 2008 crisis — to a period of tighter liquidity as the major central banks resort to monetary tightening. The US Federal Reserve, for instance, has been shrinking its balance sheet since October 2017, and the European Central Bank has announced to end its bond-purchasing programme by this December.
- India is however likely to continue receiving FDI flows as it is long-term money and global investors see better prospects in a fast-paced economy such as ours. ICRA expects total gross FDI inflows of $45-50 billion in FY19. UBS Securities forecasts a net FDI flow of around $32 billion this fiscal, up 5 per cent from $30.3 billion the previous year.
- The bigger impact of liquidity in global markets is likely to be felt on FPI flows. After witnessing a robust inflow of $18.5 billion into the debt segment and $3.8 billion into the equity segment in FY18, FPIs turned net sellers this fiscal. The Indian debt segment has so far witnessed an outflow of $6.25 billion this fiscal, while the equity segment has seen an outflow of $3 billion.
- Since these flows are more short-term in nature, they are likely to be affected by the hardening yield in the US, the depreciating rupee and the ongoing trade war.
- Other components such as loans and banking capital are likely to bring an additional capital flow of around $20 billion this fiscal, according to experts. However, they believe that this will not be sufficient to offset the outflows from FPIs.
- The sudden and strong reversal in foreign money flows this year is the major factor that would take the overall BoP into deficit. Experts say that, even if FPIs turn net buyers in the coming months, it may not help, as the quantum of outflow is already huge.
- According to UBS Securities, the BoP deficit can be $22-27 billion. They also see a danger of this deficit widening to $30 billion if the intensity of the FPI outflows increases in the coming months.
- The tariff war between the US and China can roil the picture further. Experts see a risk of global growth slowing down if the trade war intensifies. Such a scenario may have both positive and negative impacts on India.
- The prospects of a fall in commodity prices, including oil, due to a global slowdown could ease India’s import bill — a positive. But at the same time, risk aversion in the market may trigger a strong rally in safe-haven assets such as the US dollar. This will see further depreciation of the Indian rupee, and may also result in increased foreign money outflows.
- The uncertainty regarding the trade war will continue to weigh on emerging economies such India unless both the US and China settle the disputes amicably.
Oil prices are projected to be around $75/barrel and we expect an average trade deficit of $16 billion per month. With this, we project the current account deficit to widen to $70 billion in FY19. This will be about 2.7% of GDP. For the first time in seven years, we are looking at a BoP deficit of around 1% of GDP
Tanvee Gupta Jain Chief India Economist, UBS Securities
At present, we forecast the current account deficit for FY19 to increase to 2.8 per cent of GDP. We will relook at this estimate once additional details are provided on the measures to be taken by the government to curb imports or boost exports. Given the size of the FPI outflows so far in FY2019, we continue to expect a BoP deficit for the year
Aditi Nayar Principal Economist, ICRA
Portfolio capital outflows in this fiscal year has been $9.3 billion due to a strong US economy and dollar. This is expected to turn India’s overall BoP into deficit this fiscal, after a period of six years, thereby implying forex reserves depletion of $16 billion. We expect the rupee to end between 70 and 73 this fiscal
Soumya Kanti Ghosh Group Chief Economic Adviser, SBI