The current account deficit which has started to rapidly expand, needs to be watched closely
With economic activity slowly moving towards pre-pandemic levels and central banks beginning to withdraw their easy monetary policies, India’s external account could come under pressure in the coming quarters. Signs of stress have already emerged in the balance of payments statement for the September quarter of 2021 with current account deficit moving up to 1.3 per cent of GDP or $9.6 billion. Of concern is the fact that basic balance (current account deficit and FDI), which indicates durable current account funding, turned negative in the September quarter. The deficit in the current account was mainly due to trade deficit expanding quite sharply led by increase in crude oil prices and it’s clear that the cushion provided by decline in commodity prices as well as lower demand in 2020 will no longer be available going forward. While India has been consistently recording a current account deficit over the past two decades, the difference now is that there is growing uncertainty in capital flows which could induce stress on balance of payments.
The rupee has been reasonably resilient in December despite the mounting pressure; the forex reserve that the RBI has accumulated over the last two years has proved useful in curbing currency volatility. But central bank intervention to support the rupee has its limitations; forex reserves have begun shrinking since November. The RBI should speed up the process of inclusion of government securities in global bond index. With estimated annual inflows amounting to almost $40 billion in 2022 as a result of this inclusion, the rupee as well as the external account will get some support. Besides this, structural moves to address the trade imbalance such as initiating production linked incentives for more sectors and improving domestic availability of gold should receive more attention.