Why A Current Account Surplus Is Undesirable For An Economy Like India

Even though India has sporadically posted a current account surplus in the recent past, the murmurs of a sustained surplus are doing the rounds. Nevertheless, it is not a favourable prospect for India in order to stay on its economic growth trajectory.

There is a lopsided view among economists on whether the country can attain current account neutrality or, for that matter, a current account surplus in the coming months. But there is a commonality in all these views: commodity prices.

With crude oil prices inching towards $100 per barrel, "any talk of neutrality goes away", according to Rahul Bajoria, chief India economist at Barclays. On Thursday, Brent crude prices crossed $97 a barrel.

In the June quarter, India’s current account deficit stood at $9.2 billion, or 1.1% of GDP, on account of a higher trade deficit, coupled with a lower surplus in net services and a decline in private transfer receipts. This was lower than 2.1% reported in the same quarter last year but higher than 0.2% of GDP reported in the January-March quarter.

"It was in the lows of near 1% of GDP and was comfortably funded by robust capital flows," said Madhavi Arora, lead economist at Emkay Global Financial Services Ltd. Arora expects higher crude oil prices, a rise in core imports, and a further slowdown in service exports will widen the deficit in the coming quarter.

"All of this will imply the 2Q CAD/GDP ratio could be more than double that of 1QFY24, ranging from 2.4 to 2.6%," she said.

In the preceding quarter, it stood at $1.3 billion. To put it in context, the prices of crude oil—India's largest imported commodity—were around $75–80 per barrel.

The last time it recorded a surplus was in the first quarter of FY22, at $6.5 billion, or 0.9% of GDP. In the last decade, India has posted a current account surplus only four times. The rarity of this phenomenon comes from the fact that India's imports generally outstrip its exports to the rest of the world.

"The cyclicality of commodity prices and the demand conditions of the economy will keep us in deficit in the foreseeable future," Bajoria told BQ Prime.

The devil lies in the details.

A record increase of 26.6% in services exports in the last financial year, combined with five-year-high remittance inflows, led to the current account deficit narrowing sharply in the March quarter. Besides software, India's highly skilled segments such as fintech, banking and insurance services, hospitality, biotech, logistics, and medical care have contributed significantly.

This cushioned the gap caused by a miniscule rise of 6% in merchandise exports to $447 billion in the same period. Services imports, on the other hand, grew 22.2% to $179.7 billion in 2022–23.

In the merchandise trade, India's exports have remained fairly stagnant in the last decade, despite the Indian GDP growing well at an average of 5%. The import bill, however, has shot up on account of military, microchips, technology, and commodity imports.

Therefore, it is imperative for India to boost its merchandise exports for sustainable growth and to build competitiveness, according to JP Morgan's Sajjid Chinoy.

"We are seeing a world that is becoming more protectionist, so we have to work really hard to boost our goods export," the chief India economist at JP Morgan India told BQ Prime on the sidelines of the India Investor Summit on Monday.

Barclays' Bajoria expects India's current account deficit to be 1–1.5% of GDP in the next couple of years. However, the driving factors of economic growth in the event of a potential increase in domestic income would be watched out for, he said.

While Chinoy pointed out that a current account surplus is "an indication of depressed demand," it is not desirable, given the country's low per capita income. The onus of economic growth lies with a combination of foreign capital, domestic savings, and private capex, he said.

"Operationally, you will see that even if the service exports have picked up, when we get the private capex that we have been waiting for and domestic demand strengthens and broadens, that will show up in higher imports. We need capital goods imports to reflect the fact that our capex cycle has started," Chinoy said.

Axis Bank Ltd.'s Chief Economist, Neelkanth Mishra, however, has a different view.

India has a high chance of achieving current account neutrality if oil prices stabilise and the country continues to grow at over 6%, Mishra told BQ Prime earlier. India's demographic reasons also increase the likelihood of entering a current account surplus, he said.

However, the preference lies in running a current account deficit for reasons similar to what Chinoy stated.

While India's imported inflation has been the talk of the town for several years, Bajoria pointed out that the country's energy consumption growth is lower than the real GDP growth. This essentially means a scenario where India is decoupling its economic growth from energy demand.

"What is starting to become a little bit visible is that the energy intensity of growth appears to be declining at the margin... This could be a reflection of renewable energy coming into play or being able to get more growth out of the same level of energy consumption—basically productivity," Bajoria said.