CAD may widen to 3-3.2% in FY12

Firm oil prices and renewed weakness in global demand could impact import bill.

First, the good news: The current account deficit (CAD) narrowed sharply to $5.4 billion in the fourth quarter of FY11, compared to $10 billion in the previous quarter. What does this figure indicate as far as health of the external sector and the economy is concerned? The narrow CAD reflects good traction in the exports of goods and services.

In fact, exports have outpaced imports in this quarter, which reflects the gradual slowing of the domestic economy. This quarter saw exports rise by a healthy 47.1 per cent year-on-year, led by engineering goods, petroleum products and agriculture exports, while imports rose 27.4 per cent on the back of higher domestic demand for chemicals, gold, silver and electronic goods. Apart from the export of goods, software services exports also rose, along with remittance inflows. This helped the current account deficit to narrow. Going forward, this is expected to continue, as the outlook for software services seems robust, and remittances, too, should sustain at current levels, if not more.

This is where the good news ends. Robust global demand may have held up exports, but the steadily deteriorating demand situation in the domestic market has impacted capital flows. Therefore, improvement in the CAD has been more than offset by a sharp fall in net capital inflows to 1.7 per cent of GDP ($8.2 billion) in the last quarter of the FY11, from 2.9 per cent ($13.4 billion) in the third quarter.

A big reason for this has been the underperformance of Indian markets in the current calendar year, which has seen a steep drop in equity inflows. Going by the performance of the economy in the last quarter, the new financial year is also expected to be a mixed bag, with downside risks. Standard Chartered has revised its Balance of Payments outlook for FY12 to $14.5 billion against the initial estimate of $17.5 billion. Standard Chartered is not the only one to downgrade India’s BoP.

The downgrade is driven by certain fundamental factors that will impact India over the first half of FY12. While improvement in trade ties with countries like the US may help accelerate exports, the deterioration in local fundamentals will drag growth down. Also, firm commodity prices and choppy investor risk appetite would continue to be an overhang in the first half of FY12. Edelweiss expects the current account deficit to widen to 3.0-3.2 per cent of GDP in FY12, as exports moderate owing to softening commodity prices and renewed weakness in the global economy.
 

BALANCE OF PAYMENTS
$ billion	Q3 FY11	Q4 FY11	Q4FY10	FY11	FY10
Exports	66.0	77.2	52.5	250.5	182.2
Imports	97.4	107.1	84.1	380.9	300.6
Trade balance	-31.4	-29.9	-31.6	-130.4	-118.4
Invisibles net	21.5	24.5	18.8	86.2	80.0
Software exports	14.7	16.7	14.0	56.8	48.2
Remittances	13.4	13.9	12.6	53.4	52.1
Capital account	14.0	7.4	15.0	57.3	51.8
Accretion to reserves	4.0	2.0	2.1	13.0	13.4
Capital account comprises inflows via FDI, FII, ECB, short-term credit and banking capital