Anaemic portfolio flows, combined with an outflow of buyers’ credit, hurt India’s balance of payments position in Q1FY19. It
wasn’t so much the current account deficit (CAD), which came in at 2.4% of GDP, that resulted in a fall in reserves of $11.3 billion as much as the weakness on the capital account. Even in Q4FY18, India had seen strong capital account flows that had resulted in a surplus of a robust $13.2 billion in the overall BoP.
But, the situation has taken a turn for the worse. From strong capital account flows of $25 billion in Q4FY18, the flows in Q1FY19 have dropped to just $5.2 billion. Net FDI flows were, however, reasonably good; at $9.7 billion, these were higher than the levels in Q4FY18. However, the bond markets have seen outflows to the tune of $6.4 billion with money moving back to the US on the back of interest rate hikes there. Foreign portfolio investors sold stocks of the order of $2.7 billion. Moreover, some $3.6 billion worth of loans moved out, and there was less banking capital, too.
As is clear from the trade deficit data for July—when the CAD widened to $15.8 billion—things are likely to get worse in the coming months. The pressure points are clearly the elevated crude oil prices—currently at over $75 per barrel—and a weak currency given the rupee has depreciated all the way to levels of 72 against the dollar. The oil bill this year will certainly be bigger than last year’s $109 billion.
Unless there are curbs on imports—particularly, of consumer goods—it is hard to see how the CAD can be reined in. Imports of electronics in the four months to July, for instance, have crossed $18 billion and account for more than 10% of imports. This is an unnecessary expenditure. Exports are expected to do better with some help from the weaker rupee, but may see only a modest improvement since global trade could slow down in the wake of the tariff war between the US and China. Countries like India could be caught in the crossfire; at this point, it doesn’t look like exports will top last year’s $309 billion by too much. In that case, the merchandise deficit this year could come in at closer to $190 billion.
But, it is the capital account that is the bigger worry because portfolio flows in July and August have been insignificant. FDI needs to hold up and the government should consider easing restrictions in sectors such as multi-brand retail because this is stable capital. Around $40-50 billion of net FDI would come in handy at a time when portfolio flows are unreliable.