Current account deficit, a long story short – The Economic Times

Clipped from: https://economictimes.indiatimes.com/opinion/et-commentary/current-account-deficit-a-long-story-short/articleshow/88884354.cmsSynopsis

Higher global oil prices and larger gold imports – around $5 billion per month – have played a key role in pushing up India’s CAD more than anticipated. But the non-oil, non-gold imports momentum is also significantly strong. Non-oil, non-gold imports remained buoyant at 38% year-on-year in October-December 2021 vs 45% year-on-year in July-September 2021, despite the base effect turning less favourable. A few factors may explain this dynamic.

Kaushik Das

Kaushik Das

India chief economist, Deutsche Bank AGIndia’s trade deficit has shot up from September 2021 onwards, with the October-December 2021 total rising to $65 billion from $44 billion in July-September 2021. The October-December 2021 current account deficit (CAD) is now estimated at about $30 billion, or 3.6% of GDP. This is a significant increase compared to the July-September 2021 out-turn of $9.6 billion deficit (or 1.3% of GDP).

Factoring in a slightly lower CAD in January-March 2022, resulting from the likely disruptions on account of the third wave, the CAD for FY2022 still works out to $52 billion, or 1.7% of GDP. This is a significant swing from the current account surplus of $24 billion (0.9% of GDP) recorded in FY2021. The upward revision for FY2022 also pushes up the CAD forecast for FY2023 to 1.9% of GDP ($66 billion) from the earlier 1.6%.

Oil, Gold Add to CAD
Higher global oil prices and larger gold imports – around $5 billion per month – have played a key role in pushing up India’s CAD more than anticipated. But the non-oil, non-gold imports momentum is also significantly strong. Non-oil, non-gold imports remained buoyant at 38% year-on-year in October-December 2021 vs 45% year-on-year in July-September 2021, despite the base effect turning less favourable. A few factors may explain this dynamic.

First, given that India’s current account balance had turned into a surplus in April-June 2021 due to the lockdowns announced in different states during the second wave, the current large increase is partly a reflection of subsequent pent-up demand, even after adjusting for the price effect. In that sense, the increase in CAD should be a welcome sign, and a reflection of domestic demand increasing at a faster pace. Indeed, given the trade and CAD trend, consumption and investments growth within GDP is expected to remain strong in October-December 2021, even after accounting for a less favourable base.

The second point can be explained through the savings-investment dynamic of the economy. A sharp rise in CAD (or foreign savings) is essentially a reflection of a shortfall in domestic savings compared to the investment needs of the economy. While the government is trying to push up spending to support growth, so as to crowd-in private investments, domestic savings is, however, falling short to fund such investment needs – even at a reduced level of investments compared to past years. This is leading to an increase in CAD or foreign savings to bridge the gap.

This does not imply that the Indian economy is overheating, which is normally associated with a sharp increase in CAD. In fact, it suggests quite the opposite, particularly if one considers the negative output gap that still exists at this stage.

Given this dynamic, the policy thrust should be to increase jobs and income, so as to be able to raise the savings rate of private households, particularly given that fiscal deficit (government dissavings, or the amount spent being more than the amount earned) will take time to reduce. GoI is expected to set a fiscal deficit target of 6.5% of GDP for FY2023, against a likely 7% of GDP revised estimate (RE) for FY2022. Otherwise, pressure on CAD will remain elevated to fund the domestic savings-investments gap (unless investments adjust downward to meet the reduced savings, which is an undesirable objective), which could put pressure on the rupee during temporary periods of ‘capital stop’ or outflows.

Higher Rates to Be Fed In
Also, negative real rates should be reduced over the coming quarters so as to prevent potential macro imbalances, misallocation of capital and mispricing risks over the medium term. The US Federal Reserve is expected to hike interest rates three or four times in 2022, probably starting the hiking cycle from as early as March, and resort to quantitative tightening from Q3 2022 (reduction of balance sheet). This is expected to reduce the quantum of negative real rates persisting in the US significantly by the end of this year.

As real rates become less negative in the US, this can put pressure on emerging market currencies, including on the rupee, if rate normalisation outside US is delayed too much. Keeping the US rate-hike timeline in mind, one can expect the Reserve Bank of India (RBI) to hike the repo rate by 50 basis points (bps) in 2022 (probably by 25 bps in June and October), taking it up to 4.5% by the end of this year, preceded by a 40 bps increase in reverse repo rate during the April policy, with a change of stance to neutral from accommodative.

Even then, India’s real rates will remain negative, as consumer price index (CPI) inflation is expected to average 5-5.5% in FY2023, even as the CPI-based retail index reached a six-month high of 5.59% in December. Under this modest rate hike scenario, India should be able to maintain a real GDP growth of 7.5% year-on-year in FY2023, after a likely 9-9.5% year-on-year out-turn in FY2022.

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