Thanks to the sharp spike in oil prices, as also due to a fat bill for electronics, the current account deficit (CAD) in Q2FY19 had widened to $19.1 billion, the highest level in five years. But, should crude oil prices stay at these levels, we are unlikely to see another colossal $50 billion merchandise deficit as we did in the September quarter. There are some troubled spots though. For instance, we are not likely to see a repeat of the record levels of $31 billion in invisibles. These were boosted by bigger private remittances that usually tend to go up at times when the rupee depreciates sharply. Indeed, remittances grew 24% y-o-y, the highest growth in six years and, unless the currency weakens, we should not hope for transfers of such amounts. Which is why, it is critical to ensure export earnings from software services of $18-19 billion continue to flow in every quarter.
The bigger concerns, however, lie with the capital account. For a number of reasons, the strong Q2FY19 capital account surplus of $16.3 billion will, in all probability, shrink in the coming quarters. Firstly, the swing in the capital account came largely from the much smaller buyers’ and suppliers’ credit of just a negative $1.2 billion in the September quarter compared with a negative $10 billion in the June quarter. Also, banking capital shrank to just $522 million from a whopping $10 billion in Q1. Moreover, outflows from the bond and equity markets in Q2FY19 were smaller at $2.3 billion versus $9.1 billion in Q1FY19. While the trend seems to have reversed with small inflows in November and in December so far, globally, markets are volatile and portfolio flows, fickle at the best of times, are becoming very unpredictable. The sharp depreciation in the currency fuelled big FPI withdrawal sales in the bond markets in September and October and another bout of weakness in the rupee could trigger further withdrawals. In fact, the usually reliable foreign direct investment (FDI) flows, too, were smaller by about $2 billion in the September quarter. That is a big concern because big ticket investments are unlikely ahead of the general elections next year.
Already, unfriendly regulations in sectors such as telecom, oil and gas and other minerals seem to be stymieing flows; reforms like those in labour would stimulate higher exports. Given it is the capital account that defines a sustainable BoP, it looks like the very small BoP deficit of just $1.86 billion in Q2FY19—compared with a fairly large $11.3 billion in Q1FY19—was a blip. A bigger BoP deficit could once again pressure the currency.