Trade deficit: CAD may moderate to 2% of GDP in Q4FY23

Higher services’ surplus offset double-digit merchandise deficit

trade deficit, economy
A sharp rise in India’s CAD suggests a commensurate fall in India’s gross domestic savings (GDS) as investments failed to match the rise in CAD. (IE)

India’s current account deficit (CAD) widened to $3,640 crore (or 4.4% of GDP) in Q2FY23, marking the highest CAD in nine years. In a rare occurrence, Q1FY23 CAD was revised down to $1,820 crore from $2,390 crore . The widening deficit in Q2 was on account of a double-digit merchandise trade deficit, which was partly offset by a improvement in services’ surplus.

Notably, India’s CAD excluding gold stood at $2,660 crore in Q2FY23, surpassing the previous worse of 3% of GDP in Q3FY13. Similarly, the current account surplus excluding gold and petroleum products was just $860 crore during the quarter, resulting in the lowest surplus on record. This confirms that the worsening of CAD was broad-based.

At the same time, India’s foreign capital inflows amounted to just $690 crore in the quarter, down from $2,200 crore in Q1FY23 and $3,960 crore in Q2FY22. Net FDI flows were just $640 crore in Q2FY23, augmented by FPI inflows of $650 crore v/s net outflows in the previous three quarters. Accordingly, there was a drawdown of foreign exchange reserves (FXR) to the order of $3,040 crore in Q2FY22, marking the highest drawdown since the 2008 Great financial crisis in Q3FY09.

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A sharp rise in India’s CAD suggests a commensurate fall in India’s gross domestic savings (GDS) as investments failed to match the rise in CAD. Our calculations suggest that India’s GDS fell to 28.3% of GDP in Q2FY23, lower than 28.6% in Q1 and 32.4% of GDP a year ago in Q2FY22.

We believe that the worst in terms of CAD is behind us. Although CAD is expected to remain high (3-3.5% of GDP) in Q3FY23, it may moderate quickly to 2% of GDP in Q4FY23. With lower-than-expected CAD in Q2FY23, we revise down our FY23 CAD forecasts to 3.1% of GDP from 3.6% forecasted earlier.

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India’s CAD now stands at 3.3% of GDP in 1HFY23, compared to a small deficit of 0.2% of GDP in 1HFY22 and a surplus of 3% of GDP in 1HFY21. Although merchandise deficit has doubled in 1HFY23, the surplus on invisibles account (i.e., services + incxome) increased 28% y-o-y to 5.5% of GDP. Importantly, however, foreign capital flows dried up in 1HFY23, leading to a drawdown of $2,560 crore in India’s FXR 1HFY23. Notably, the total fall in FXR was $7,460crore in 1HFY23, almost two-thirds of which was accounted for by the adverse valuation effect.

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First published on: 02-01-2023 at 01:40 IST
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