Macro-economic forecasts and analysis
Real-time analysis of data releases and copious indicator data
Fiscal 2017-18 ended with a current account deficit of USD 48.7 billion or 1.9 per cent of GDP. This marks a sudden and substantial deterioration of the CAD compared to the previous year when it was just 0.7 per cent of GDP.
CAD had reached crisis levels in 2011-12 and 2012-13 when in absolute terms it averaged over USD 80 billion and as a per cent of GDP it was well above 4 per cent. The situation improved dramatically in 2013-14 and it continued to improve thereafter till 2016-17.
Improvement in the CAD since 2013-14, however, has come about by India reducing its trade engagement with the world. All inflows and outflows of goods & services and primary & secondary income together as a per cent of GDP peaked at 62.9 per cent in 2012-13. This proportion declined slightly to 61 per cent in 2013-14 and then it fell sharply for three consecutive years to 46.5 per cent in 2016-17. In 2017-18 the ratio improved slightly to 47.4 per cent. But, the average ratio for the past three years, at 47.6 per cent, was lower than in any of the preceding 10 years.
Arguably, this cannot be a preferred way of balancing the external payments accounts.
The deterioration in CAD during 2017-18 was entirely because merchandise trade recorded a bigger deficit of USD 160 billion compared to a deficit of USD 112 billion in 2016-17.
Inflows on account of goods trade (exports) increased by USD 29 billion - from USD 280 billion in 2016-17 to USD 309 billion in 2017-18. However, the increase in outflows on account of goods trade (imports) was much more, by USD 77 billion, from USD 392 billion to USD 469 billion, in the same period. As a result, net outflow on merchandise goods increased by USD 48 billion.
Customs data indicate that the deterioration in trade balance during 2017-18 was largely on account of non-petroleum products whose trade deficit deteriorated from USD 53 billion in 2016-17 to USD 91 billion in 2017-18. Petroleum trade deficit deteriorated lesser, from USD 55 billion in 2016-17 to USD 71 billion in 2017-18.
This raises a question of what would happen when in 2018-19 the deficit on account of petroleum products also rises because of the recent increase in crude oil prices.
The increased merchandise trade deficit of USD 47.6 billion was partly offset by a USD 10 billion net increase in inflows on account of services trade, which rose to USD 77.6 billion in 2017-18. The increase in net inflows from services is a relief because it comes after two consecutive years of a fall in the net contribution from the services sector. It fell by nearly USD 7 billion during 2015-16 and then again by USD 2.2 billion in 2016-17.
The big contributors to this increase in services trade were a USD 3 billion increase in professional and management services, a USD 2.1 billion increase in computer services and a USD 2 billion increase in travel. The rise of professional and management service is new and substantial. Its contribution at about USD 10 billion now matches that of travel and tourism.
Personal transfers, which include worker remittances and local withdrawal of NRI deposits, contributed to a net inflow of a substantial USD 62 billion during 2017-18. It also clocked an increase of almost USD 7 billion during the year. Yet, remittances are low compared to their levels during 2013-14 and 2014-15 when they averaged USD 63 billion in a year.
Net outflows on account of investment incomes have been rising steadily. In 2017-18 these amounted to USD 33 billion, which implies an increase of USD 4 billion over the previous year. According to ‘India’s External Debt - A Status Report’, released by the ministry of finance, the implicit cost of borrowing externally was benign and falling. In 2016-17, it was 2.8 per cent on an average. The implicit interest rate on NRI deposits was 4.4 per cent and on ECBs was 4.7 per cent.
However, interest rates are likely to increase and an increased reliance on these funds could raise the outflows on investment incomes substantially.
Given the increase in outflows of investment incomes in recent times and the rising current account deficit it is important that the deficit is financed from relatively more stable sources rather than the volatile ones.
Direct investments are a more stable source of capital and they have been the main source of financing of the CAD. However, these have been falling since 2015-16 when it peaked at USD 45 billion. It fell to USD 42 billion in 2016-17 and then further to USD 39 billion in 2017-18. In contrast, portfolio investments have moved from an outflow of USD 4 billion to an inflow of USD 7.6 billion and then USD 22 billion in the same period.
NRI deposits bounced back with an inflow of USD 9.7 billion after a USD 12 billion outflow in 2016-17. Similarly, external commercial borrowing also bounced back with an inflow of USD 6.5 billion after outflows for four consecutive years before this. Trade credit doubled from USD 6.5 billion in 2016-17 to USD 14 billion in 2017-18. These have been the major sources of funding the CAD.
The share of relatively volatile inflows such as portfolio investments, NRI deposits, ECBs and trade credit in financing the CAD was much higher in 2017-18 compared to its share during the preceding two years when FDI was the chief financier. But earlier, it was always the biggest contributor to financing the CAD.