Rising foreign direct investment (FDI) inflows and low commodity prices continue to narrow India’s external financing needs and mitigate the risk of a potential widening of the current account deficit (CAD) related to weakening remittances, Moody’s Investors Service said on Thursday.
“We do not expect a significant renewed widening of India’s current account deficit,” said Marie Diron of Moody’s sovereign risk group. The rating agency’s assessment was based on assumptions that commodity prices would remain low in 2016 and 2017. Also, FDI inflows could climb further in response to government measures, such as efforts to liberalise foreign investment limits in several sectors and the ‘Make in India’ initiative.
“These trends are credit positive, as they lower India’s susceptibility to external shocks at a time when capital flows to emerging markets are volatile, and weak economic conditions globally and, in particular, in the Gulf states, may dampen remittances,” added Diron. The Asian Development Bank has projected India’s CAD to be 1.6% of GDP in FY17, up from 1.3% in FY16, but at a much comfortable level than nearly 5% in FY13.
The Moody’s report said that a lower energy import bill and policy measures to contain gold imports were contributing to keeping the trade deficit at moderate levels. Going forward, the announcement in the latest budget of the imposition of an excise tax on gold might dampen overall gold imports. The value of oil imports decreased by 37.5% — or Rs 3.0 trillion ($44.3 billion) — in the 12 months to February 2016 compared with the previous year, despite a 10% increase in the volume of petroleum imports.
However, the prospect of subdued global economic activity — in particular in the Gulf states, the origin of more than half of remittances to India — may lead to a significant and prolonged weakening of remittance inflows. “This development is likely to prevent India’s current account from returning to balance and could lead to its renewed widening,” Moody’s said.
The rapid rise in FDI inflows mitigates the risks related to a possible widening of the CAD from weaker remittances by diminishing India’s external financing needs from other inflows in the form of credit and equity inflows.
Net FDI inflows into India hit an all-time high in January 2016, at $3 billion on a 12-month moving average basis. India’s CAD is now more than covered by its FDI inflows. “The rise in FDI points to stronger investor interest in India on the back of robust economic growth,” it said. India’s economy is expected to grow by 7.6% in FY16, up from 7.2% in FY15.
“The development of industrial corridors, investment and manufacturing zones, and smart cities will further bolster investment inflows. In particular, flows into the manufacturing sector are likely to accelerate as the government seeks to boost the sector’s share of GDP to 25% by 2022,” said Diron.
In the past, India has easily financed its deficits with robust FDI and portfolio inflows. Moody’s expects some shift in the composition of capital flows towards FDI, and away from portfolio flows, therefore, increasing the stability of financing, and supporting the sovereign’s credit profile.