On 29th September, the RBI published the current account numbers for the first quarter of FY23 (Q1FY23) ended June 2022. Not surprisingly, the current account deficit widened from $13.40 billion in March 2022 quarter to $23.90 billion in June 2022 quarter. This was largely due to a rise in the merchandise trade deficit. The June 2022 current account deficit (CAD) is close to the December 2021 quarter deficit. However, at 2.8% of GDP, the CAD is much lower than the estimate put out by India Ratings at 3.4% of GDP for Q1FY23.

In the last 12 quarters, India has reported 8 quarters of deficit on the current account and 4 quarters of surplus on the current account. But, the surplus on current account was more on account of the COVID pandemic and can almost be treated as outliers. The fact is that the last 4 quarters have seen current accounts deficits in succession and that is not too encouraging. It must be remembered that a wider current account deficit not only has implications for the rupee, but also could potentially become a reason for downgrading the sovereign ratings. But we will come back to these points later on.



Chart Source: RBI

Why the current account deficit widened in June 2022 quarter

For the June 2022 quarter, the current account deficit widened sequentially from $13.40 billion to $23.9 billion. This is the fourth successive quarter of current account deficit. There were 3 key reasons for the current account deficit widening in the Q1FY23 quarter.

a)      Firstly, the merchandise trade deficit widened sequentially from $-54.5 billion in the March 2022 quarter to $-68.6 billion in the June 2022 quarter. This was largely on account of exports stagnating amidst fears of a global recession.

b)      What is more interesting, and perhaps disconcerting, is that the POL (petroleum, oil, lubricants) accounted for nearly half of the overall merchandise deficit for the June 2022 quarter at $-33.6 billion. A lot of the pressure came from the weakening rupee.

c)      For the June 2022 quarter, the services surplus did improve sequentially from $28.3 billion to $31.1 billion. However, the services surplus was not sufficient to offset the sharp spike in the merchandise trade deficit in the June 2022 quarter.

d)      Primary outflows on account of payments on investments in the form of interest and dividends widened from $8.40 billion to $9.30 billion, but still lower than Dec-21.

India has seen sharply higher imports of crude oil, fertilizers, coking coal and minerals. While commodity price rise has partly contributed to this wider trade deficit, the key driver has also been imported inflation due to consistently weakening rupee. Oil imports hold the key.

Breaking up the current account for June 2022 quarter

In FY21, India had reported a small current account surplus, but that had dipped to a current account deficit in FY22. Going by the early indications, FY23 appears to be a huge gap on the current account, with estimates ranging from 3% of GDP to 4% of GDP. Here is a quick breakup of how the CAD of $23.9 billion was arrived at.

Pressure on Current Account (CA)	Amount	Boosting the Current Account (CA)	Amount
Q1FY23 Trade Deficit	($68.60 bn)	Q1FY23 Services Surplus	+$31.10 bn
Primary A/C - Interest	($9.30 bn)	Secondary Income	+$22.90 bn
Negative Thrust on CA	(-77.90 bn)	Positive Thrust on CA	+$54.00 bn
		Current Account Deficit	(-$23.90 bn)

Data Source: RBI

The real number to watch out for in the remaining 3 quarters of FY23 is the trade deficit. For instance, the cumulative trade deficit for the first 5 months of FY23 stands at $124.5 billion, which would work out to an annualized trade deficit of $300 billion approximately, if the current run is maintained. Assuming that the current account deficit is normally 30% to 40% of trade deficit, we are looking at a current account deficit for FY23 in the range of $100 billion to $120 billion. That would be anywhere between 3% and 4% of GDP. The situation is still nowhere as alarming as it was in 2013, but the data is challenging enough for the alarm bells to start ringing in the Commerce and Finance Ministries.

Merchandise trade deficit could really hold the key to FY23 CAD

The cumulative overall deficit of $-79.10 billion represents the overall deficit after the services surplus is used to offset the merchandise trade deficit. It must be noted that the services data is with a lag of 1 month so extrapolations are used, but these are quite close to the real picture. At the existing run rate, the overall deficit could end up closer to $170 billion and could pose a real challenge to the current account deficit (CAD) levels in FY23. Let us look at the overall deficit numbers for the first 5 months of FY23 (April to August), as reported by the Commerce Ministry.

Particulars	Exports FY23 ($ bn)	Imports FY23 ($ bn)	Surplus / Deficit ($ bn)
Merchandise trade	$193.51 bn	$318.03 bn	$(-124.52) bn
Services Trade #	$118.30 bn	$72.88 bn	$+45.42 bn
Overall Trade	$311.81 bn	$390.91 bn	$(-79.10) bn

Data Source: DGFT (# - DGFT estimates due to 1-month lag in RBI reporting)

If we make a provision for the primary outflows and the secondary income for the first months, the current account deficit should be approximately around $60 billion as of end of August 2022. That approximately matches with the estimates that India could see current account deficit in the vicinity of around $120-130 billion for FY23, which will translate into a CAD of around 4%. It must be remembered that the real pressure of the trade deficit widening to around $30 billion per month only started in the second quarter. The second quarter and the third quarters could hold the key to the real picture of FY23.

RBI policy could be a double edged sword. If RBI stays passive, then imported inflation will continue to widen the current account deficit. With the RBI hiking repo rates by another 50 bps in September to 5.90%, the Indian rupee will get a better defence mechanism. The hope is that it works out that way!

Surprisingly, the current account deficit narrowed from $22.16 billion in December 2021 quarter to $13.40 billion in March 2022 quarter. This was largely on account of moderation of the trade deficit and lower net outgo of primary income (which is largely the interest costs). We will come back to this point later.

In the last 12 quarters, India reported a current account deficit in 8 quarters and a current account surplus in 4 quarters. Three out of these four quarters of current account surplus were at the peak of the COVID crisis when the imports had sharply dipped amidst zero economic activity in India. The other time India had reported a current account surplus was in June 2021 when COVID had reared its head violently. Ironically, in India, current account surplus has been synonymous with bad times while a current account deficit has been synonymous with relatively better times.



Chart Source: RBI

Why the current account deficit narrowed in March 2022 quarter?

For the March 2022 quarter, the current account deficit eased sequentially from $22.16 billion to $13.40billion. This marks the third successive month of current account deficit. There were 3 key reasons for the current account deficit narrowing in the Q4FY22.

1. Firstly, the merchandise trade deficit narrowed from $-60.4 billion in the Dec-21 quarter to $-54.5 billion in March 2022 quarter. This was largely on account of exports keeping pace with the rise in imports and higher crude prices.
2. For the March 2022 quarter, the services surplus improved sequentially from $27.8 billion to $28.3 billion. This combined with the lower trade deficit helped the cause of reduction in current account deficit sequentially.
3. Primary outflows on account of payments on investments in the form of interest and dividends fell sharply on a sequential basis from $11.70 billion to $8.40 billion.

The concern is that the trade deficit has been rapidly widening. The trade deficit could touch $250 billion in FY23 and that could add a lot of pressure on CAD. Apart from crude oil, imports of coke, coal, gold and fertilizers also saw a spike in fiscal year FY22.

How the current account looks like in March 2022 quarter

In FY21, India had reported a small current account surplus due to the $35 billion surplus generated in Jun-20 and Sep-20 quarters.
However, as imports picked up steam since then, trade deficit and the current account deficit have gradually widened. Here is a break-up of the current account deficit in the March 2022 quarter.

Pressure on Current Account (CA)	Amount	Boosting the Current Account (CA)	Amount
Q4 Trade Deficit	($54.50 bn)	Q4 Services Surplus	+$28.30 bn
Primary A/C - Interest	($8.40 bn)	Secondary Income	+$21.20 bn
Negative Thrust on CA	(-62.90 bn)	Positive Thrust on CA	+$49.50 bn
		Current Account Deficit	(-$13.40 bn)

Data Source: RBI

The current account deficit in March 2022 has been $7.76 billion lower than in December 2021. This is largely on account of lower merchandise trade deficit, lower primary account outflows and a marginally higher services trade surplus. However, if you look at the current run rate of imports, total merchandise trade deficit could cross $250 billion in FY23. That is going to put a lot of pressure on the current account deficit and there is no way the services trade can meaningfully mitigate that effect.

Current Account Deficit for fiscal year FY22

When the RBI announced the current account numbers for the fourth quarter, it also announced the numbers for the full year FY22. Here are
key current account takeaways for FY22.

• Total current account deficit for FY22 stood at $-38.7 billion as compared to a current account surplus of $24 billion in FY21.
• Effectively, the current account as a percentage of GDP moved from a surplus ratio of 0.9% in FY21 to a deficit ratio of -1.2% in FY22.
• The biggest contributor to the current account deficit in FY22 was the merchant trade deficit at $189.5 billion. However, this was partially compensated by the full year services trade surplus of $107.5 billion in FY22.
• Primary outflows in FY22 were higher at $37.3 billion on account of interest and dividend payments. This was more than compensated by a 10% spike in secondary income in fiscal FY22.
• The current account deficit of $-38.7 billion was largely offset by net capital inflows of $38.2 billion during FY22. The heavy FPI outflows were more than compensated by heavy inflows via the FDI route as well as a surge in banking capital.
• For FY22, when the impact of the current account and the capital account flows were combined, the gross accretion to forex reserves was $47.5 billion. However, out of this, $17.2 billion was reduced on account of valuation changes in non-dollar holdings. As a result the net accretion to the forex reserves was just about $30.3 billion in FY22.

In short, the pressure on the current account is likely to remain, and perhaps, deepen in the fiscal year FY23.

Will merchandise trade be the villain in June 2022 quarter?

The cumulative overall trade deficit combining merchandise and services trade stood at $(8.08) billion in April 2022 but burgeoned to $(27.30) billion in May 2022. That represents a sharp increase of $19.22 billion to overall deficit (trade plus services) in just the last one month. At the existing run rate, the overall deficit could end up closer to $150 billion and could pose a real challenge to the current account deficit (CAD) levels in FY23.

Particulars	Exports FY23 ($ bn)	Imports FY23 ($ bn)	Surplus / Deficit ($ bn)
Merchandise trade	$78.72 bn	$123.41 bn	$(-44.69) bn
Services Trade #	$45.87 bn	$28.48 bn	$+17.39 bn
Overall Trade	$124.59 bn	$151.89 bn	$(-27.30) bn

Data Source: DGFT (# - DGFT estimates due to 1-month lag in RBI reporting)

How does this figure look in comparison? India closed FY21 with combined deficit of $-12.75 billion or $1.06 billion a month. The combined deficit in FY22 was $-87.79 billion, or $7.32 billion a month. If you consider the first 2 months of FY23, India could close FY23 with an overall deficit in the vicinity of $150 billion, substantially higher than FY22. That is likely to put a lot of pressure on the current account, with its concomitant impact on the rupee value and also on the sovereign ratings.