Small current account deficit hides serious problems
The small CAD of just $300 million in Q1FY17, unchanged from levels seen in Q4FY16 and near a nine-year low, might be comforting, but the fact that it missed estimates by a wide margin is not—consensus pegged it at a surplus of $2.7 billion. The surprise came from sharper than expected drop in private remittances which fell for the third straight quarter. While the CAD may be compressing, the fact that much of it is on the back of weak imports rather than any growth in exports cannot be encouraging. Crude oil prices continue to stay soft, which is a boon, but the continuing contraction in non-gold, non-oil imports is unhealthy since it means companies are reluctant to create fresh capacity or even ramp up production. Of course, this doesn’t really come as a big surprise since visibility on demand remains poor and there is a fair amount of surplus capacity. The bigger worry, perhaps, is that merchandise exports remain weak, after having contracted for close to two years now, implying little improvement in demand in markets overseas. While there has been some discussion on trying to keep the rupee weak, experts have pointed out this would have little effect since it is global incomes that matter more—in which case, the government needs to help make exporters more competitive in other ways.
Worse, there is now an apprehension that earnings from software services, which were flat at $17.5 billion in Q1FY17, might end the year only marginally higher than in FY16, partly because of the fallout of Brexit. Indeed, invisibles as a whole could fall for the second consecutive year in FY17 since workers’ remittances could be smaller than in FY16 by about $5 billion. Around 52% of remittances flow in from countries in West Asia and since their economies have been badly hit by falling crude oil prices—these have now fallen for the third consecutive quarter in Q1FY17.
The other disappointment this time around, is the halving of net FDI flows to just $4.1 billion from $8.8 billion in Q4FY16 and $10 billion in Q1FY16. Some economists say the slower inflows reflect shrinking PE money into the e-commerce space but believe they will rebound given initiatives taken by the government to attract investments. Nevertheless, it is unlikely flows will match the $36 billion seen in FY16. Essentially, a swing in banking capital from a negative $9 billion to a small negative of $0.1 billion and a pick-up in FII flows to $2.1 billion is what helped leave a surplus in the balance of payments. Nevertheless, the net accretion of $7 billion to the forex reserves, the best in four quarters, will come in handy as the redemption of FCNR (B) deposits starts. Given banks have an estimated $30 billion in their nostro accounts, they could use some of this to redeem the deposit. Economists believe that only if withdrawals cross $15 billion will the rupee and liquidity be impacted. As such, the BoP surplus may continue with FDI picking up later in the year. However, the quality of the surplus, coming as it does from contracting imports rather than rising remittances, exports or sticky FDI flows, is far from satisfactory.