Weak exports, combined with a bigger oil bill, pushed India’s current account deficit (CAD) to 1.9% of GDP in 2017-18, much above the 0.6% of GDP in 2016-17. If the overall balance of payments (BoP) came in at a surplus of $43.6 billion, it was thanks to strong capital account flows of $91.4 billion. This was driven by net FDI flows of some $30 billion, bond market inflows of $20 billion, loans of $16.7 billion, $16.2 billion of banking capital and $6 billion of other capital. However, this year the merchandise deficit could be much higher, widening the CAD. If capital flows slow as they well could, last year’s BoP surplus is likely to turn into a deficit of around $20-22 billion.
The pressure points on the current account side are clearly the elevated crude oil prices and weak exports. The oil bill, this year, will certainly be bigger than last year’s $109 billion. Although there is good news from the US in that growth is picking up—evident from the US Fed’s decision to increase interest rates and also its guide for another two hikes this year—the tariff wars could disrupt global trade queering the pitch for countries like India. The weakening rupee will give exporters only little headroom to compete because the currencies of peer economies have also depreciated. In sum, exports do not look like they are going to top last year’s $309 billion by a substantial amount; consequently, last year’s merchandise deficit of $160 billion could turn into $175-180 billion this year. Net invisible receipts—services and remittances—which rose smartly to $111.3 billion last year can be counted on to stay strong but cannot take care of the bigger import bill.
There are pressure points on the capital account side too. While India has attracted large foreign direct investment (FDI) flows of $61 billion in 2017-18 and $60.2 billion in the previous year, the net FDI flows actually moderated to $30.3 billion in 2017-18 from $35.6 billion in 2016-17. So, while the robust trend in gross inflows could well spill over to the current year, especially if the government eases norms for certain sectors, the net inflows need to be watched.
Again, 2017-18 saw a chunky $20 billion flow into the bond markets, but foreign portfolio investors (FPIs) have sold around $5 billion worth of bonds since April 3. With interest rates in India rising, ideally, foreign portfolio flows into the debt market should increase because the differential in rates between the US and India would be high. However, a sharply depreciating currency would put off debt investors who typically do not hedge their portfolios. It is hard to tell how big equity inflows into India will be this year since the markets are overvalued, corporate earnings are not picking up as expected and, in a lot of the top quality stocks, FPI investments are already at high levels. Most importantly, the general elections are due in March-April next year and investors would be understandably cautious. Even last year, equity inflows were very subdued at just about $1.6 billion. Again, it is difficult to estimate the flows of short-term credit which shored up capital flows last year. Suddenly, domestic savings are becoming critical, as are measures to curb imports with the CAD looking like it could hit 2.5% of GDP this year, well out of the country’s comfort zone.