India’s Worsening Current Account And Portfolio Outflows
India’s current account is worsening quickly, weighed down by high oil prices. At the same time, portfolio outflows are large and have undone the large inflows of 2021, says the Institute of International Finance.
These are delicate developments in a global environment characterized by high recession risk and tighter monetary policy, it says in its latest report.
Cheap Russian oil and government measures to discourage gold imports are unlikely to change India’s external outlook meaningfully.
“We estimate they will improve the current account by just 0.3-0.4% of GDP. If oil remains at $100, we project a current account deficit of 3.7% of GDP in the next twelve months. It will be among the widest in EM,” says analysts at the firm.
This figure is lower than in the run-up to the taper tantrum but still risky in a difficult global environment.
Risk is to the downside if the economy recovers fully from the shadow banking and covid crises, as imports would rise further and widen the current account deficit.
“In this context, we expect continued depreciation pressure on the rupee. Despite recent nominal depreciation, the real exchange rate has not fallen much and will not prompt significant adjustment to high oil prices.”
Worsening Trade Deficit
India’s trade deficit is growing quickly in the context of a recovering economy and high commodity prices. The trade deficit in H1 was the highest since 2013 (Exhibit 1).
Vulnerability however is lower than in the run-up to the taper tantrum when current account deficits reached 5% of GDP.
On an annualized basis, the H1 trade deficit is 0.8% of GDP lower than in 2013. That said, exports of goods are weaker than a decade ago. Oil accounts for the lion’s share of the rise in total imports, although non-oil imports have picked up too (Exhibit 2).
“In our forecast, we work with a central scenario where oil prices remain around $100 for the next year. Oil imports from Russia have attracted attention recently, both for geopolitical reasons and for potential savings.
“We estimate that in June shipments from Russia accounted for a fifth of India’s oil imports, up from less than 5% in recent years (Exhibit 3). Assuming Russian oil sells at a 40% discount to Brent, we estimate annual savings of 0.3% of GDP.”
The IIF says new export taxes on oil products may lower exports and eat partially into savings from cheap Russian oil.
In addition to oil export taxes, the government increased tariffs on gold imports by 4.25%.
“We estimate the combined impact of these measures to be 0.3-0.4% of GDP, non-negligible but unlikely to move the current account enough to lower overall vulnerability (Exhibit 4).
“Our current account forecast for the next twelve months is a deficit of 3.7% of GDP (Exhibit 5). We assume exports, particularly services, remain resilient, an assumption subject to downside risk if global growth slows markedly.
“We project strong non-oil imports but not to the degree observed in 2012, reflecting our view that GDP growth will not go back to the 7-8% range, at least in the near term.”
Current account deficit
“Short of falling oil prices, we do not see any catalysts for external adjustment. Despite nominal depreciation, the real exchange rate is at late 2019 levels,” says the Institute.
Terms of trade have moved against India but adjustment via the exchange rate may not happen soon.
On the economic activity front, there are reasons to think the current account deficit could widen further. Growth has been subpar since the shadow banking crisis of 2018-19 and covid. Output is still below the weakest pre-2018 trends (Exhibit 6).
“We do not expect a spurt of strong growth but do think that part of this negative output gap will close. When it does, domestic demand and imports will rise. In other words, India’s underlying current account deficit may be higher than 4% of GDP. Given fairly sizable external imbalances, we expect continued depreciation pressure.” it says.
