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ANALYSIS

Current account deficit to deteriorate further

by Mahesh Vyas

The current account deficit deteriorated during 2017-18. In the first quarter the deficit touched 2.5 per cent of GDP. Although this recovered to 1.1 per cent in the second quarter, it fell to 2 per cent of GDP in the third. We expect the fourth quarter to have ended at 1.5 per cent of GDP. The year will therefore have ended with a current account deficit of about 1.8 per cent of GDP. This would be the largest deficit since 2012-13.

The current account deficit is projected to increase further to 2.4 per cent in 2018-19 and to 2.5 per cnt of GDP in 2019-20 under benign conditions. It could get worse.

The deterioration of the current account is essentially because of a sharp increase in the deficit on merchandise trade. We are expecting a merchandise trade deficit on payments account of the order of USD 160 billion during 2017-18. In 2016-17, the deficit was USD 112 billion. The trade deficit had been shrinking since its peak in 2012-13. But, in 2017-18, the deficit increased substantially.

Trade data from DGCI&S suggest that while exports grew by 9.9 per cent in 2017-18, imports grew by a much faster 19.7 per cent. All major segments of imports - petroleum, gold & silver and the rest - grew in handsome double-digits during 2017-18. This led to a sharp increase in the trade deficit.

The increase in merchandise trade deficit is sharp at USD 48 billion. This is partly offset by the USD 12 billion increase in the surplus on the services account. IT exports are the major source of this surplus. While these exports are growing, their momentum has declined. Protectionism in destination markets have hurt growth. We expect these exports to continue to grow but at a rate slower than implied in the past trend.

Net revenues from computer services added up to USD 54 billion during the first three quarters of 2017-18. We expect the year to end with a net revenue of USD 73 billion compared to USD 70 billion in 2016-17.

Outgo on account of “primary income” which is income from investments into equities and debt instruments in India has been increasing steadily in response to the continued increase in foreign investments into India. These have been of the order of USD 25 billion a year.

“Secondary income” is a source of net revenues for India. About half of this is remittances of Indians working abroad. Worker remittances spiked to USD 40 billion momentarily in 2014-15. They have since dropped to USD 35 billion. Seondary income dropped from USD 66 billion in 2014-15 to USD 56 billion in 2016-17. The first three quarters of 2017-18 saw a small recovery as worker remittances already totalled USD 30 billion and total secondary income was USD 46 billion. We expect the year to end with a net inflow of USD 62 billion on the secondary account.

Broadly therefore, 2017-18 is expected to have ended with a current account deficit of USD 46 billion arising from a deficit of USD 160 billion on merchandise trade, a surplus of USD 79 billion on services trade, a deficit of USD 27 billion on primary income and a surplus of USD 62 billion in secondary income.

We expect the current account deficit to worsen in the coming four years. It is projected to range between USD 67 billion and USD 79 billion a year. While merchandise trade is projected to continue to increase, the offsetting surpluses from services are expected to remain flat. Trade deficit is expected to increase from USD 161 billion in 2017-18 to about 190 billion. But, the surplus on services is expected to stagnate close to USD 78 billion.

Similarly, while the deficit on primary incomes (interest and dividends repatriated or reinvested by foreigners in India) is projected to increase - from USD 27 billion in 2017-18 to USD 38 billion, the increase in secondary income is projected to be a lot more sedate - from USD 62 billion to USD 72 billion.

The deficit is expected to be covered comfortably by a mix of direct investments and trade credit in 2017-18. Portfolio investments provided a substantial USD 24 billion to capital flows. USD 19 billion had flowed during the first three quarters. Net portfolio investments had peaked at USD 41 billion in 2014-15. But, these flows have been volatile. Direct investments have been far more stable, bringing in over USD 30 billion a year. In 2017-18, they are likely to bring in USD 34 billion.

In 2018-19, we expect net inflows from direct investments to decline and portfolio investments to turn marginally negative. We expect inflow on capital and financial accounts to be inadequate to finance the current account. A small drawdown of USD 15 billion of reserves may be required. This, however, would not make any material impact on reserves.