Current Account Deficit narrows to 1.0% of GDP in Q2 FY24

28 Dec 2023 , 09:28 AM

CAD moderates in Q2FY24, but risks remain

The second quarter current account deficit (CAD) data has been announced by the RBI at $8.3 billion or 1.0% of the GDP. Even for the first half of FY24, the CAD remains at a manageable 1.0% of the GDP, which can be seen as a reasonable position to be in at the end of half year. It needs no reiteration that the current account deficit (CAD) is on of the most sought after data points published by the RBI each quarter. Typically, the RBI reports the CAD with a lag of one quarter i.e., the September quarter CAD gets reported towards the end of December, and so on. The current account deficit is a significant data point as it shows the extent to which India’s services surplus is able to offset the merchandise trade deficit. It also has repercussions for the rupee value and sovereign ratings of India.

For the September 2023 quarter (Q2FY24), the current account deficit (CAD) was reported at $8.3 billion, which compares favourably with $9.2 billion or 1.1% of GDP in the first quarter ended June 2023 (Q1FY24). But before we go into the numbers, a quick word on what the CAD reflects. It is an extension of the trade deficit. While the trade deficit only includes the merchandise trade, the CAD also includes trade in services and other primary and secondary incomes. But that is not the point. The real thing to understand here is that while the CAD position looks comfortable at the half way stage of FY24, there are still risks. For instance, a spike in the price of crude oil can have a deep impact on CAD. Also, global commodity prices have been subdued for over a year and any turnaround can have an impact on CAD. Above all, global spending on technology and outsourcing is a major source of surplus in the services account. That still assumes a sharp revival in US growth.

How CAD panned out over last 12 quarters

The table captures the current account balance trend for the last 12 sequential quarters.

Quarter	Current Account Balance
Quarter Ended December 2020	$(2.2) billion
Quarter Ended March 2021	$(8.1) billion
Quarter Ended June 2021	$6.58 billion
Quarter Ended September 2021	$(9.71) billion
Quarter Ended December 2021	$(22.16) billion
Quarter Ended March 2022	$(13.40) billion
Quarter Ended June 2022	$(18.00) billion
Quarter Ended September 2022	$(30.90) billion
Quarter Ended December 2022	$(18.20) billion
Quarter Ended March 2023	$(1.30) billion
Quarter Ended June 2023	$(9.20) billion
Quarter Ended September 2023	$(8.30) billion

Data Source: RBI

Here are some of the major takeaways from the time series data on current account deficit for the last 12 quarters.

• The current account deficit had peaked at $30.9 billion in the September 2022 quarter, which is when the government had expressed concerns about a possible spike in the CAD for FY23. However, the CAD was contained in subsequent quarters.

   

• The limiting of CAD in subsequent quarters has been progressive and it is thanks to a lower trade deficit and an improvement in the services surplus. However, in October 2023, India had reported a record trade deficit of $31.5 billion, the highest in history. That will only show up in the CAD figure of the December 2023 quarter.

   

• In the last 3 years, there has been just one occasion in the June 2021 quarter, when India had reported a current account surplus, and that was due to the pressures of COVID resulting in a sharp reduction in the trade deficit. 

   

• At $8.3 billion for the September 2023 quarter, the current account deficit is 1.0% of GDP. This is lower than the current account deficit reported in the sequential June quarter at $9.2 billion and sharply lower than the current account deficit of $30.9 billion reported in the year ago September 2022 quarter. 

   

• What helped to reduce the current account deficit in the September 2023 quarter? Two factors favoured the current account situation in September 2023 quarter. On  yoy basis, the lower merchandise trade deficit helped. This was largely due to Russian oil. At the same time, the surplus on services account was meaningfully higher at $40.0 billion in the September 2023 quarter as compared to just $34.4 billion in the June 2023 quarter. 

 

How CAD basket shifted in the September 2023 quarter?

Pressure on Current Account	Q2 FY24 Break-up	Q2 FY23 Break-up	Boost to Current Account	Q2 FY24 Break-up	Q2 FY23  Break-up
Trade Deficit	($61.00 bn)	($78.30 bn)	Services Surplus	+$40.00 bn	+$34.40 bn
Primary A/C – Interest	($12.20 bn)	($11.80 bn)	Secondary Income	+$24.90 bn	+$24.80 bn
Negative Thrust on CA	(-$73.20 bn)	(-$90.10 bn)	Positive Thrust on CA	+$64.90 bn	+$59.20 bn
			Current Account Deficit (CAD)	(-$8.30 bn)	(-$30.90 bn)

Data Source: RBI

The current account deficit for the September 2023 quarter was lower on a sequential basis. Here are the components of September 2023 CAD compared with September 2022 quarter.

1. Firstly, the merchandise trade deficit had narrowed sequentially to $(61.0) billion in the September 2023 quarter. This compares favourably with $(78.3) billion deficit CAD in the year-ago quarter. However, the trade deficit was sequentially higher than the $(56.6) billion reported in the June 2023 quarter. This is largely on account of the discount on Russian oil imports compressing from around $25/bbl to just around $5/bbl. The secular falling trend in merchandise trade deficit can be attributed to lower commodity prices and weak import numbers, although the oil impact has been recently hardening.

    

2. What is more interesting is that the POL (petroleum, oil, lubricants) deficit accounted for 29.34% of the overall trade deficit in the September 2023 quarter. This compares favourably with the 42.9% of the overall merchandise trade deficit in the sequential June 2023 quarter. This is also sharply lower than the 37.7% share that POL had of the trade deficit in the year ago September 2022 quarter. This also means that while the oil driven deficit has fallen, the deficit from non-oil commodities like fertilizers, coal, ores, gold, silver, alloys, and chemicals; has been on the risk in the latest quarter.

    

3. The big story in June 2023 (Q1FY24) quarter was the growth in services surplus. The service surplus had stood at $34.4 billion in Q2FY23, $38.7 billion in Q3FY23 and $39.1 billion in Q4FY23. In Q1FY24, the services surplus tapered to $35.1 billion due to a slowdown in exports of services amidst weak global demand on the back of slowdown concerns. However, the services surplus was still better on a yoy basis compared to $31.1 billion in the year ago quarter (Q1FY23).

    

4. Primary outflows on account of payments on investments in the form of interest and dividends increased sequentially from $10.6 billion in Q1FY24 to $12.2 billion in Q2FY24. This is on account of higher pay-outs on in-bound investments amidst rising inflows from FDI and FPI flows. Primary outflows were also higher on a yoy basis compared to Q2FY23. The secondary income has been largely stable on a yoy basis.

Overall, the trends from the CAD story appear to be encouraging for the September 2023 quarter. The full year current account deficit for FY23 stood at $67 billion; sharply lower than the expected range of $100 billion to $125 billion. For the current fiscal FY24 the full year CAD should be well under $50 billion, even in the worst-case scenario.  That should rein in the CAD for FY24 below 1.5% of the GDP, which would be relatively comfortable. 

How the CAD basket shifted in H1-FY24

Pressure on Current Account	H1 FY24 Break-up	H1 FY23 Break-up	Boost to Current Account	H1 FY24 Break-up	H1 FY23  Break-up
Trade Deficit	($117.7 bn)	($141.4 bn)	Services Surplus	+$75.1 bn	+$65.5 bn
Primary A/C – Interest	($22.8 bn)	($20.6 bn)	Secondary Income	+$47.9 bn	+$47.7 bn
Negative Thrust on CA	(-$140.5 bn)	(-$162.0 bn)	Positive Thrust on CA	+$123.0 bn	+$113.2 bn
			Current Account Deficit (CAD)	(-$17.5 bn)	(-$48.8 bn)

Data Source: RBI

With the data available for the first half of FY24, here is a comparison of the current account basket for the first of FY24 vis-à-vis the first half of FY23.

1. For the first half of FY24, the merchandise trade deficit sharply narrowed yoy to $117.7 billion compared to $141.4 billion in H1-FY23. This can be largely attributed to the discount on Russian oil imports, as Russia emerged as the largest contributor to the Indian oil basket, beating OPEC along the way. The fall in merchandise trade deficit can also be attributed to lower commodity prices and weak import numbers.

    

2. What is more interesting is that the POL (petroleum, oil, lubricants) deficit accounted for 34.6% of the merchandise trade deficit in the first half of FY24. In contrast, the POL deficit accounted for 39.5% of the merchandise trade deficit in H1-FY23 . This also means that while the oil driven deficit has fallen, the deficit from non-oil commodities like fertilizers, coal, ores, gold, silver, alloys, and chemicals; has been on the rise in the first half of FY24.

    

3. The big story in first half of FY24 (H1FY24) quarter was the growth in services surplus. The service surplus for H1FY24 stood at $75.1 billion compared to just $65.5 billion in the year ago first half of FY23. This is despite the fact that the services surplus also had a small setback in the current fiscal year on account of the weak tech demand from the US amidst cuts in expenditure. That has been largely rectified in the latter part of FY24.

    

4. Primary outflows on account of payments on investments in the form of interest and dividends increased to $22.8 billion in H1FY24 as compared to $20.6 billion in H1FY23. This is on account of higher pay-outs on in-bound investments amidst rising inflows from FDI and FPI flows. The secondary income has been largely stable on a yoy basis.

The H1FY24 CAD at $(17.5) billion is sharply lower compared to $(48.8) billion in H1FY23. While it may be too early to extrapolate, it looks like the CAD should stay under 1.5% of GDP for the full year, even if you were to factor in the worst-case scenario. That should surely give a lot of comfort to the Indian rupee and also to the risks to the sovereign ratings. 

Will the Q2FY24 CAD impact government policy response?

The Indian government had already taken proactive steps to bring the CAD under control, although some of them may bear fruit in the medium term. It is giving a thrust to exports of goods and services through the PLI scheme. On the other hand, it is also following a conscious policy of import substitution. That has helped to cut the merchandise trade deficit in the non-oil space. Apart from cutting imports of high-priced oil, the government has taken big strides to in-source substantial parts of the defence purchase basket. It remains to be seen if the supply cuts by the OPEC really lead to a sharp spike in crude oil prices, although it does look fairly unlikely at this point of time. One area where the PLI appears to be delivery quick results is in electronic exports with the likes of Apple making India a key part of its global iPhone export plans.

The one major X-factor could be the rupee value. Here is why. While RBI members in the MPC are still hawkish, the RBI has held policy rates since February 2023 to ensure that the growth engine is not disrupted. However, now, the good news is that even the Fed has turned less hawkish and has even guided for seven rate cuts in 2024 and 2025. The impact is already evident in the US bond yields falling sharply and the dollar index weakening. For the RBI, it makes that job that much easier. If need be, the RBI can cut rates, even if it means some weakness in the rupee. That is a good situation to be in!