CAD came in marginally lower at 1.1% of GDP in FY16 than Ind-Ra's expectation of 1.2%.It narrowed to USD22.1bn in FY16 as against USD26.8bn in FY15 primarily led by a contraction in the trade deficit to USD130.1bn from USD144.9bn. CAD for 4QFY16 came in at USD0.3bn (0.1% of GDP), sequentially lower than USD7.1bn (1.3% of GDP) in 3QFY16, and also marginally lower than USD0.7bn (0.1% of GDP) in 4QFY15.
A low CAD suggests stability on the external front. However, there are two sides to a lower CAD for an economy like India that is reliant on private transfers, mainly remittances, and services exports to maintain a healthy and sustainable current account position. On one side, the low crude prices and collapse in the global prices of commodities have resulted in a lower trade deficit. On the other side, oil-rich economies in the Middle East have suffered due to low oil prices, which impacted the remittances of workers working overseas. Remittances or private transfers declined to USD63.1bn in FY16 from USD65.5bn in FY15. On a quarterly basis, private transfers declined to USD15.2bn in 4QFY16, which is the lowest since 1QFY12. Services exports declined to USD69.7bn in FY16 from USD76.5bn in FY15. Within services, software services sequentially declined to USD17.3bn in 4QFY16, which is a lower level than in the previous three quarters of FY16 although it has held up on a yearly basis (FY16: USD71.5bn; FY15: USD70.4bn).
On the whole, India appears to be a net beneficiary of low oil prices despite low services and merchandise exports. The import of crude petroleum and its products declined to USD52.4bn in FY16 from USD81.5bn. Ind-Ra believes sluggish global growth and weakness in prices will continue to impact exports growth, while weak domestic demand will keep a check on imports growth.
Net foreign direct investment inflows increased to USD36bn in FY16 from INR32.6bn in the previous year. However, sequentially net foreign direct investment inflows declined to USD8.8bn in 4QFY16 from USD10.7bn in the previous quarter. Net portfolio investment recorded a net outflow of USD4.1bn in FY16 (net inflow of USD41bn in FY15). In 4QFY16, portfolio investment outflow was USD1.5bn mainly due to debt outflows of USD970m.
The forex reserves increased by USD17.9bn in FY16, which is much lower than the USD61.4bn accretion to forex reserves registered in FY15. In 4QFY16, the accretion to forex reserves was lower at USD3.3bn than the USD4.1bn in the previous quarter and USD30.1bn in 4QFY15.
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In the past, net inflow in the capital account has been the saviour of a high CAD. However, a closer look at the 4QFY16 numbers suggests that capital account surplus in 4QFY16 was the lowest since 2QFY14. Foreign currency non-resident deposits maturity starting from September 2016 is likely to put further pressure on the overall capital account, but given the forex reserve and the Reserve Bank of India's (RBI) advance planning, it is unlikely to be disruptive.
The rupee will be mostly supported by the comfortable current account gap in FY17. As the concern from US Federal Reserve's action has mostly been alleviated, the scope for an uptick in domestic growth and global risk appetite will determine the rupee trajectory. In the near term, UK's referendum will be critical, and Brexit can cause major instability in the global currency market. Nonetheless, Ind-Ra expects the rupee to remain stable due to a steady domestic macroeconomic environment.
From the bond market perspective, embryonic forex flows may be fruitful. With limited scope for a considerable improvement in portfolio flows, open market operations purchase will remain the preferred option for RBI to keep systemic liquidity at ease. In the current conjecture, with the least visibility of any rate action by RBI, incremental open market operations purchase could be the major determinant of the bond market performance henceforth.
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