CAD may jump over 5% of GDP in Q2FY23, relief likely in the next fiscal

The current account deficit may have widened to 3.4% of the gross domestic product in the first quarter against a surplus of 0.9% a year ago

The country's current account deficit (CAD) is expected to be at a nine-year high of 3.4-3.7 per cent of its gross domestic product (GDP) during the first quarter of the current financial year. A more serious development would be that the CAD is likely to widen to 5.5 per cent of GDP in the second quarter, which would be the second worst after the quarterly deficit on record after 6.8 per cent in the third quarter of 2012-13.

According to a report by Motilal Oswal Financial Services Ltd (MOFSL), the CAD could widen to 3.7 per cent of GDP in the first quarter due to India’s external situation worsening quickly against a surplus of 0.9 per cent a year ago.

The data for the first quarter could come any time now.

"Although the data for Q1, FY23 is not yet published, the monthly data available on goods & services confirm that the CAD may have widened to 3.7 per cent of GDP or $ 31.3 billion," the report said.

According to India Ratings (Ind-Ra), the CAD may have widened to 3.4 per cent of GDP in the quarter against a surplus of 0.9 per cent a year ago.

Before April-June of 2022-23, CAD was higher at 4.7 per cent of GDP in the first quarter of 2013-14.

In terms of absolute amount, CAD at $28.4 billion in Q1 of FY23 may have touched the highest level in 38 quarters, the rating agency said. Before this, the deficit was wider at $31.8 billion in the third quarter of 2012-13.

CAD was at $13.4 billion or 1.5 per cent of GDP in the fourth quarter of 2021-22.

MOFSL said CAD may widen to a scary level of 5.5 per cent of GDP in the second quarter of 2022-23.

India Ratings too said early signs showed that the deficit may remain elevated in the second quarter, too, as exports growth slowed, crude prices remained elevated and the rupee depreciated against the dollar. However, it did not specify its estimates.

It said merchandise exports touched a record high of $121.2 billion in Q1FY23. Ind-Ra said they are likely to slow down and come in at $104.2 billion in the second quarter of the year, growing by just 1.4 per cent year-on-year (YoY) due to global headwinds.

The International Monetary Fund (IMF), in its July update, trimmed its forecast for global GDP growth to 3.2 per cent from 3.6 per cent in April 2022. Also, GDP forecasts of some of India’s key exporting destinations such as the US, Europe, and China have been revised downwards. This may put India’s export targets of $750 billion (goods and services) for FY23 in jeopardy.

On the other hand, Ind-Ra expected merchandise imports to remain robust due to elevated global commodity prices (Brent crude averaged $100.7 a barrel in August) and a weak rupee. The agency expected the rupee to average 79.6 against the dollar in Q2 of this financial year.

Merchandise imports grew 40.5 per cent YoY in July-August 2022 to $128.2 billion and are expected to come in at $192.2 billion in Q2 of FY23, increasing by 30.3 per cent YoY.

Ind-Ra expected the merchandise trade deficit to come in at a fresh high of around $87 billion in Q2 of FY23.

The crucial issue in the balance of payments is whether the country would be able to finance its CAD through capital inflows.  

If one looks at two main components of capital inflows — foreign portfolio investment (FPI) and foreign direct investment (FDI) — it looks difficult that the CAD would be financed through these inflows and there could be some drawdown from forex reserves in the first and second quarters.

FPIs net sold $14.3 billion in the first quarter of FY23 from Indian markets. However, the FDI inflow was at $13.7 billion during this period.

This meant that there was a net outflow of $0.6 billion from these two accounts during the period. So, the entire $28.4 billion or $31.3 billion (the range on the basis of India Ratings and Motilal Oswal's report) have to be financed through other sources such as NRI deposits, otherwise, there would be withdrawal of forex reserves.

However, portfolio investments in the second quarter so far (till September 23) were positive at $11.3 billion. There was also a net FDI inflow of $5.2 billion in the month of July. So, the trend is positive but if MOFSL's estimates come true, CAD would be an alarming $44.6 billion in the quarter. This means higher inflows from FPI and FDI are needed or else NRI deposits and other heads need to be quite high to finance CAD. Otherwise, there would be withdrawal from forex reserves.

For the entire year, CAD may widen to a decade high of 3.8 per cent of GDP in 2022-23, said MOFSL. If this happens, the financial services advisory firm estimated that forex reserves are likely to reduce by $77 billion in the year.

The deficit has moved from a deficit of two per cent of GDP each in FY18 and FY19 to 0.9 per cent of GDP in FY20. For the first time in 17 years, India had posted a surplus on its current account at 0.9 per cent of GDP in FY21. Starting Q4FY20, the current account balance moved into a surplus zone. It, however, reversed quickly to a deficit of 1.2 per cent of GDP in FY22.

As of September two this year, the RBI’s holding of forex reserves has already dropped to $553 billion, which is expected to decline by another $23 billion during FY23, said MOFSL.

The country is likely to get relief from the high CAD of FY23 in the next financial year.

Nikhil Gupta, chief economist at MOFSL said, "From as high as 3.7 per cent of GDP in the first quarter of FY23, the CAD could widen further to 5.5 per cent of GDP in the second quarter, implying CAD at 3.8 per cent of GDP in FY23, the highest in a decade. The only relief is that a mix of lower commodity prices and weaker domestic growth (along with weak global growth) is likely to pull down CAD to 2.1 per cent of GDP in FY'24 (estimates)."

Devendra Pant, chief economist at India Ratings said CAD will be significantly higher in Q2.

"This will deplete forex reserves and will continue to pressurise the currency. The currency will depreciate further unless outflows of international capital reverse. Capital outflows have reversed partly of late. If the slowdown or stagnation of developed economies continues, it will be a bigger problem for India from the CAD and currency point of view," he said.