India’s current account deficit (CAD) rose sharply to $9.2 billion in the first quarter (April-June) of this year from $1.3 billion in the preceding, January-March, quarter. However, on a year-on-year basis, there was some good news, as it represented a fall from the $17.9 billion seen in the same quarter last year, according to data released by the Reserve Bank of India.
The current account deficit — as different from the capital account — reflects the difference between the value of goods and services a country imports and exports. A deficit means the country is importing more than it is exporting. Ideally, a country should have a balanced current account, with the foreign exchange earned from exports being used to pay for the imports.
When there is a deficit, the country is forced to use the foreign exchange earned on the capital account — which represents money brought in from the outside to buy assets in India — to fund the gap in the trade or current account.
Unlike current account items, capital account transactions come with obligations and a change in ownership, and have to be repaid at some point in the future. But current transactions are ‘final’ and do not have to be repaid. it is therefore considered better to have a surplus on the current side than a deficit that is funded by capital inflows.
The deterioration in India’s current account was broad-based. All three items — merchandise trade, services trade and income account — showed deterioration.
Merchandise Trade Deficit
The merchandise trade deficit increased to $56.6 billion (or 6.6% of GDP) in Q1FY24 compared to $52.6 billion (6% of GDP) in the previous quarter. This was mainly driven by lower merchandise exports, particularly non-oil exports which fell to $105 billion in Q1FY24 from $115.8 billion in the previous quarter and $122.8 billion in Q1FY23.
On the other hand, oil exports remained robust at $18 billion in Q1FY24, up from $15.3 billion in the previous quarter, although lower than $26.9 billion in Q1FY23. However, rising oil exports also pushes up oil imports, as India first imports crude oil, refines it, and then exports the products.
Net net, the trade deficit in merchandise stood at 6.6% of GDP in Q1FY24 compared to 6% in the previous quarter and 7.4% in Q1FY23.
Services Trade Surplus
The surplus in services trade came down to a four-quarter low of $35 billion (4.1% of GDP) in Q1FY24. This was mainly due to a deceleration in services exports to $80.6 billion from $85.8 billion in the previous quarter and $76 billion in Q1FY23. All forex-generative trade that takes places in non-physical goods, such as tourism and IT services exports by companies such as TCS, are part of ‘services trade’. There has been a decline in both tourism and IT services momentum in recent months due to a global slowdown.
Income Account Surplus
The surplus on the income account, which includes dividends and profits from investments made abroad as well as remittances by Indians working outside, also declined to a six-quarter low of $12.3 billion (1.4% of GDP) in Q1FY24.
Taken together, the surplus on services trade and income account is referred to as the invisibles surplus. The invisibles surplus stood at 5.5% of GDP in Q1FY24, the lowest in four quarters.
Non-Oil Current Account
Interestingly, India suffers from an current account deficit only because of oil. If we remove oil from the equation, India had a current account surplus of $16.2 billion (1.9% of GDP) in Q1FY24. However, even this was lower than the $29.2 billion (3.3% of GDP) surplus in the previous quarter.
Similarly, one can also exclude gold instead of oil. If one excludes gold purchases, India’s current account surplus was just 0.1% of GDP in Q1FY24, down from 0.6% in the previous quarter.
If both oil and gold are excluded, the country’s current account surplus was $25.9 billion (3% of GDP) in Q1FY24.
On the capital account side, there was an increase in inflows to $34.4 billion (4% of GDP) in Q1FY24 compared to just $6.5 billion (0.7% of GDP) in the previous quarter.
This was driven by a sharp increase in foreign portfolio investment (FPI) inflows to $15.7 billion in Q1FY24 compared to an outflow of $1.7 billion in the previous quarter. FPI inflows change dramatically from quarter to quarter, depending on how interest rates move in countries such as the US. Higher interest rates lead to outflows, and lower interest rates abroad lead to inflows into Indian markets.
Foreign direct investment (FDI) inflows — which represent more ‘sticky’ inflows compared to investment into share and bond markets — also moderated to $5.1 billion from $6.4 billion earlier.
Net net, because of the various factors outlined above, India’s foreign exchange reserves (FXR) increased by $24.4 billion in Q1FY24 compared to $5.6 billion in the previous quarter.
Gross Domestic Savings
Based on investments and the CAD, India’s implied gross domestic savings (GDS) decreased to 29.5% of GDP in Q1FY24 from 33.1% in the previous quarter and 28.4% in Q1FY23. The GDS is determined by deducting final consumption expenditure from GDP.
Going forward, the continued contraction in exports, higher-than-expected GDP growth and elevated crude oil prices can put upward pressure on the CAD going forward.
Against this backdrop, CAD projections have been revised upwards to 1.3% of GDP in FY2024 from 0.7% estimated earlier.
Looking at data over the past few years, India’s CAD had steadily improved from a deficit of 2.1% of GDP in Q1FY20 to a surplus of 0.9% in Q3FY23, aided by robust services exports. However, it has again turned negative in the latest quarter on account of global growth headwinds.
On the capital account side, barring intermittent slowdowns, FPI and FDI inflows have largely remained strong over the past four years. However, the Ukrainian crisis did lead to some moderation in flows over certain periods.
Overall, India’s balance of payments has remained relatively stable, with the RBI accumulating foreign exchange reserves during this period. This has provided a buffer against external shocks arising from monetary tightening in advanced economies and the energy crisis. However, the deterioration in the CAD and moderation in capital flows in the latest quarter warrants close monitoring of India’s external balance.