Even with the strong BoP surplus in FY22, the rupee is likely to remain weak—likely at 75.5 to dollar at end-Dec 2021
By Anubhuti Sahay
India’s March 2021 balance of payments (BoP) data showed one of the largest surpluses since FY08, as demand for imports fell and capital flows remained strong. Based on annual BoP data and the quarterly trajectory of BoP in FY21, we highlight three important takeaways for FY22.
First, it provides cues on the trajectory of the current account (C/A) balance, i.e., switching back to sustained quarterly deficits after a temporary surplus in June 2021 quarter. While June and September 2020 saw double-digit C/A surpluses—the first in more than a decade-and-half—the C/A balance was back to a deficit in both the December 2020 and the March 2021 quarters. We believe the local lockdowns in May will likely result in another quarter (June 2021) of C/A surplus as import demand fell, followed by a likely widening of the C/A deficit in the rest of FY22.
However, the June-quarter surplus is likely to be smaller than the corresponding FY21 quarter surplus as economic activity was less impacted and commodity prices were elevated; for instance, the Indian crude basket prices were ~100% higher in June 2021 versus last year, and net imported oil volume is estimated to be c25% higher, despite a slowdown in economic activity.
We expect the C/A balance to turn to a deficit, of -0.7% of GDP, in FY22, from a temporary surplus of +0.9% of GDP in FY21, as non-oil & non-gold demand trade deficit gets closer to the pre-pandemic levels (see graphic). Additionally, gold-import demand, which was subdued in May and June 2021, will likely surge once reopening is on a firmer footing.
India imports c900 tonnes of gold annually (FY14-19 average); it imported c140tonnes in April-June quarter. Similar to the last fiscal—when India imported 400 tonnes of gold in just four months (December 2020-March 2021) after importing only 200 tonnes in April-November 2020—realisation of pent-up demand will widen gold trade deficit along with non-gold in rest of FY22.
Second, services inflows have increased since the pandemic. Net exports of software services, which funded close to 50% of the merchandise trade deficit in the pre-pandemic period, have seen a step-up. Specifically, quarterly software net exports, that ranged $18-21 billion in FY15-FY20, increased to $23 billion in H2FY21. If this trend is sustained, highly possible given the shift to digital, expect additional annual flows of $5-8 billion.
We could see another $2-4 billion flows in the medium term as other services—such as transport and travel—resume or normalise with greater global vaccination coverage. Investment-related outflows are likely to be smaller in FY22, as the rise in dividend repatriation seen in FY21 on a regulatory change settles down in the current fiscal. Overall, even as the trade deficit is likely to widen as the economy reopens, buoyant flows (services, remittances and reduced investment-related outflows) are likely to keep the C/A deficit in check. Risks could emerge if crude oil prices stay elevated around current levels; we estimate every $1/bbl increase in prices widens the C/A deficit by $1.5 billion annually.
Third, even as the C/A balance turns to a deficit, we estimate that India is likely to record another year of a strong BoP surplus, of around $55 billion in FY22. In fact, based on our estimate, the Q1FY22 BoP surplus was already close to $20 billion on strong FDI flows and a narrower C/A balance. With investors still positive on India’s medium-term outlook, the FDI pipeline remains robust. This, along with a recovery in other flows, leads to our expectation of yet another year of a strong BoP surplus.
However, the size of the surplus might be smaller relative to Q1FY22 on a widening C/A deficit. We note that even with another year of a strong BoP surplus, the rupee is likely to remain weak—we forecast 75.50 by end of Dec 2021. In FY21, when the BoP surplus stood at $87 billion, the rupee—barring brief episodes of strength—showed a weakening bias amid strong intervention by RBI as the rise in flows was unsustainable. We think RBI will continue to add to its FX reserves in FY22 as global uncertainties on tapering/rate hikes from the Fed could exert pressure on India’s external sector, especially amid elevated commodity prices. However, strong external buffers are likely to cushion any shocks.
Head, South Asia, Economics Research. Standard Chartered Bank