Moody's: India's external financing needs narrowing, helped by low commodities prices and rising FDI

Moody's Investors Service says that rising foreign direct investment (FDI) inflows continue to narrow India's external financing needs and mitigate the risk of a potential widening of the current account deficit related to weakening remittances, a credit positive.

"We do not expect a significant renewed widening of India's current account deficit. Our assumption that commodity prices will remain low in 2016 and 2017 supports this view, although there are downside risks to our assessment. Meanwhile, FDI inflows are likely to climb further in response to government measures, such as efforts to liberalize foreign investment limits in several sectors and the 'Make in India' initiative," says Marie Diron, a Moody's Senior Vice President for the Sovereign Risk Group.

"These trends are credit positive, as they lower India's susceptibility to external shocks at a time when capital flows to emerging markets are volatile, and weak economic conditions globally and, in particular, in the Gulf states, may dampen remittances," adds Diron.

The report says that a lower energy import bill and policy measures to contain gold imports are contributing to keeping the trade deficit at moderate levels. Going forward, the announcement in the latest budget of the imposition of an excise tax on gold is likely to dampen overall gold imports. Additionally, the value of oil imports decreased by 37.5% -- or INR3.0 trillion (US$44.3 billion) -- in the 12 months to February 2016 compared with the previous year, despite a 10% increase in the volume of petroleum imports.

However, the prospect of subdued global economic activity in particular in the Gulf states, the origin of more than half of remittances to India may lead to a significant and prolonged weakening of remittance inflows. This development is likely to prevent India's current account from returning to balance and could lead to its renewed widening.

The rapid rise in FDI inflows mitigates the risks related to a possible widening of the current account deficit from weaker remittances by diminishing India's external financing needs from other inflows in the form of credit and equity inflows.

Net FDI inflows into India hit an all-time high in January 2016, at US$3.0 billion on a 12-month moving average basis. India's current account deficit is now more than covered by its FDI inflows. The rise in FDI points to stronger investor interest in India on the back of robust economic growth.

"The development of industrial corridors, investment and manufacturing zones, and 'smart cities' will further bolster investment inflows. In particular, flows into the manufacturing sector are likely to accelerate as the government seeks to boost the sector's share of GDP to 25.0% by 2022," says Diron.

The increase in FDI has happened at a time of volatile portfolio -- that is debt and equity -- flows. For India, after a rapid increase in 2014-early 2015, portfolio inflows fell markedly to around zero.

In the past, India has easily financed its deficits with robust FDI and portfolio inflows. We expect some shift in the composition of capital flows towards FDI, and away from portfolio flows, therefore, increasing the stability of financing, and supporting the sovereign's credit profile.

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