Current Account Deficit To Widen In Q3, Rupee To Remain Range-Bound, Say Economists

The current account deficit is set to widen in the ongoing quarter, though it will likely remain in check, signaling comfort on India's external sector, according to economists.

The current account deficit continued to narrow in the July–September quarter, as merchandise trade deficit lowered and service exports increased. The current account balance recorded a deficit of $8.3 billion, coming in at 1% of GDP in Q2 FY24, lower than $9.2 billion (1.1% of GDP) in Q1 FY24 and $30.9 billion (3.8% of GDP) in the corresponding quarter a year ago, according to data published on Tuesday.

However, Q3 FY24 current account deficit as a share of the GDP is likely to worsen, with a sequentially wider goods deficit, led by high imports due to the festive season. However, services will likely improve further, according to Madhavi Arora, lead economist at Emkay Global Financial Services Ltd.

The upside risks from higher crude oil prices have somewhat receded, as concerns over slowing global demand have kept Brent below $80 per barrel since November, despite the ongoing conflict in the Middle East. "Therefore, we maintain our FY24 CAD/GDP forecast of 1.4%, with lower risks from higher crude prices," she said.

CAD funding so far has been quite smooth, and H1 CY24 could enjoy some front-loaded FPI inflows, ahead of India’s bond index inclusion, according to Arora. FPI flows have returned strongly in Q3 so far; and, thus, assuming stable and low net FDI flows and improving capital flows.

Factoring in the recent trend in services exports, Suvodeep Rakshit, senior economist at Kotak Institutional Equities, and Upasna Bhardwaj, chief economist at Kotak Mahindra Bank Ltd., revised down the FY24 current account deficit estimate to 1.4% of the GDP from 1.6%.

With a pick-up in capital account flows, the current momentum is to hold up, as per a note on Tuesday. Accordingly, the balance of payments is estimated at $20 billion for FY24 from -$13.9 billion earlier.

"In FY25, we continue to monitor risks from any escalation in geopolitical conflicts, volatility in energy prices, and any volatility from the differing pace in developed markets rate easing cycles. Accordingly, we revise down our FY25 CAD/GDP estimate to 1.4% vs 1.6% earlier," it said.

Rahul Bajoria, chief economist at Barclays Plc, forecasts a current account deficit of $45 billion (1.3% of GDP) in FY24 and a modest increase to 1.5% of GDP in FY24-25. "Commodity prices, especially after a brief period of elevation, have come down, which provides some support for our view of a manageable current account deficit and mitigates the subdued external demand, Bajoria said. The services surplus also continues to be relatively resilient, despite some slowdown expected in the IT sector.

Despite risks to the current account, financing requirements are unlikely to be a concern, given India's impending bond index inclusion, Bajoria said. While most of the inflows will likely come next year (as the index inclusion is scheduled for June 2024), some front-loaded inflows are expected in FY24, possibly picking up traction in Q4 FY24, he said.

The rupee has behaved relatively well in the fiscal year to date, helped by the RBI, despite the widening trade deficit, higher Brent prices, and recent FPI equity outflows, said Arora. The RBI’s two-way intervention in recent months has helped in keeping the rupee volatility extremely low, and the currency has been range-bound as a result.

"Going ahead, depressed forward yields, unless corrected, will act as an impediment to INR’s upside potential when USD may globally face weakness," Arora said. Nevertheless, it would be difficult to take a strong directional call on the noiseless Rupee.

"While robust capital flows will provide room for appreciation in the INR, we expect the RBI’s intervention to cap any significant gains," said Rakshit, forecasting the currency to trade in the range of 82.75-83.50 in the near term.