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  1. Editorial: Comfortable CAD

Editorial: Comfortable CAD

By and large, few worries on this front

By: | Published: December 24, 2015 12:53 AM

Thanks to the collapse in commodity prices, the current account deficit (CAD) for FY16 is likely to come in at around $28 billion or around 1.3% of GDP, or much the same level as in FY15. It helps that the rupee has outperformed virtually all its peers and foreign exchange reserves are enough to cover 10 months of imports. While benign commodity prices add to the comfort level, a mild worsening of the CAD could take place next year. That is because exports, which are expected to come in at just short of $280 billion for the current year, aren’t likely to do much better next year. Indeed, despite $34-billion savings in oil imports in April-September, contracting exports (just $136 billion in April-September) have resulted in a fairly large merchandise deficit, of $72 billion. Though low oil prices have exaggerated the exports collapse, even non-oil exports are sluggish. The slow and uneven global recovery, an uncompetitive currency and the forging of trade agreements such as the TPP will continue to pressure exports and they are unlikely to hit even $300 billion in FY17. Once the economy recovers, imports could grow at a slightly higher pace. Fortunately, there are no signs yet that private transfers, which have averaged $16.5 billion in the last six quarters, are tapering off. Moreover, earnings from software services are steady at around $17-18.5 billion a quarter.

To the extent capital flows remain robust, even a slightly bigger CAD would not be cause for much concern, especially since FDI flows have been quite large. While FDI may have fallen off to around $6.6 billion in Q2FY16 from $10.1 billion in Q1, such investments tend to be lumpy, so the year could end with $30-35 billion coming in, especially since the rules have been eased. Given there are good investment opportunities, a similar amount could be expected in FY17, too. However, equity markets flows can be tricky and while some outflows were expected due the Fed raising interest rates—close to $3 billion has moved out since April—the trend might reverse only by about March on hopes of better corporate earnings. This could be partially countered by money moving into bond markets after January when the allocation will increase by $2.5 billion. While it is too early to predict FY17 flows, the Balance of Payments will be under pressure if FCNR(B) deposits of around $10-15 billion, raised in late 2013, are not rolled over and repayments of forex loans by banks aren’t refinanced. Fortunately, with the CAD so low and FDI flows so strong, as long as commodity prices remain low, we are not in even the worry zone.

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Tags: CAD

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