Expect a sharp fall in current account deficit in FY14

Experts anticipate the rupee to rise to 60 to a dollar by March-end

India’s trade deficit – the difference between merchandise exports and imports --  continues to improve with each passing month, easing pressure on the rupee and cushioning the blow from the monetary tightening by US Federal Reserve. The trade deficit fell to $9.9 billion in January this year from $10.1 billion in the previous month and $20 billion in January 2013. On an annualised basis, trade deficit is now down to $145 billion or around 7.5% of the GDP during the 12 months ending January 2014 from an all time high of 11.3% in FY13, according to figures by RBI.

 

To economists, this signals a sharp reduction in India’s current account deficit in FY14. “The trade data has been moving in the right direction and we are looking at a sharp reduction in current account deficit in FY14. CAD is likely to fall to a manageable level of 2.2% of GDP by March this year from over 5% in FY13,” says Devendra Pant, chief economist at India Ratings. 

 

A reduction in current account deficit is likely to reduce the downward pressure on rupee that has depreciated by nearly 27% in last two years. Some experts are now expecting the rupee to appreciate marginally. India Ratings for example expects the rupee to rise to Rs 60 to a dollar by the end of March and Rs 57 to a dollar by March 2015.

 

More importantly, it will reduce India’s dependence on volatile foreign capital inflows such as portfolio investments to fund current account deficit. At its peak, India required nearly $7 billion worth of capital inflows every month to fund CAD. Now this requirement will be down to around $3-4 billion a month. This could be easily funded through foreign direct investment that is highly stable and less prone to policy moves by central banks. In the last five years, inbound FDI in India has been well above $50 billion and is likely to grow further as more MNCs look to capitalize from the growth opportunity in India.

 

The only risk to this otherwise benign outlook on India’s external sector is a likely spike in imports once industrial activity revives in line with economic recovery later this year. Fall in imports, both crude oil and non-oil, have played a big role in deficit reduction. Crude oil imports were down 10.1% in January while non-oil imports were down 22%. 

 

On the brighter side, exports continue to grow, up 3.8% in January due to gains from rupee depreciation and economic recovery in Europe and the US. Experts expect this trend to continue and thus dampen the negative impact of a likely import surge next fiscal. The crisis has been averted for now.