CAD narrows, but financing concerns emerge

Higher exports and a slight dip in imports helped India’s current account deficit (CAD) narrow sharply in the quarter ended March, data showed to the relief of policymakers and investors on Thursday, even as the frenzied sell-off by foreign investors in both debt and equity segments this month threatened to undo the gains.

At $18.08 billion, CAD – the gap occurs when a country’s imports of goods, services and transfers is greater than its exports – was down to 3.6% of the gross domestic product compared with 6.7% ($31.86 billion) the previous quarter.

The data was released a day ahead of schedule by the Reserve Bank of India, and had an immediate positive impact on the struggling rupee and the equity markets. Rupee closed at 60.20 to the dollar on Thursday, up from the all-time low of 60.73 hit on Wednesday, according to Bloomberg Data. The benchmark Sensex also closed up 1%.

Export of physical goods jumped 5.9% in the quarter, while imports fell 1%.
Imports, unfortunately, fell on non-oil and non-gold components, reflecting a slowdown in the economy.

For the year ended March, however, CAD came in at 4.8%, compared with 4.2% a year earlier.

India has been struggling to contain CAD, which had climbed to unsustainable levels on the back of high gold and oil imports, in turn increasing pressure on the rupee and prices. The rupee, which has fallen 13% in the last two months, has, in fact, shown the weakest performance among all emerging market currencies.

“Surges in commodity prices and a spike in gold imports have been key factors denting the trade and current account balances in the past two years,” Barclays economists Siddhartha Sanyal and Rahul Bajoria said in a note.

Going forward, economists expect the annual deficit to slow further, thanks to lower oil prices (down 14% since touching a year high in February), curbs on gold import and a weak economy. The government has taken measures to bring down gold imports, which account for 11% of the total imports, including raising the import duty to 8% and putting in place curbs on lending against gold.

HDFC expects CAD for this fiscal to come down to 4%, while Nomura expects it to come down to 4.3%. Barclays expects it at 3.9%.

However, economists caution that financing CAD could get difficult going forward, given the recent slowdown in portfolio and debt inflows. Foreign investors have been pulling money out of the country on fears of the US halting its quantitative easing programme.

“Financing is a real threat. It cannot be emphasised more. We need large fresh supply of dollars in the country. Foreign direct investment rules need to change. But more than that, we need to think of bond issuances,” said HDFC chief economist Abheek Barua.

India saw an accretion of $3.8 billion in its foreign exchange reserves last fiscal.

Foreign institutional investors have pulled out Rs 42,628 crore ($7.28 billion) so far in June, and if the capital flight continues, financing the deficit could become a challenge.

“We expect lower capital inflows to offset any benefit from a lower current account deficit, which will maintain upward pressure on USD/INR,” said Nomura economist Sonal Varma.