India reports sharp fall in CAD to $18.2 billion in Q3FY23

3 Apr 2023 , 09:39 AM

On 31^st March 2023, RBI published the current account deficit (CAD) figures, along with the balance of payments for Q3FY23 ended December 2022. The RBI reports the CAD data with a lag of 3 months. The December 2022 quarter CAD was published on 31^st March 2023 while the Q4FY23 and the full year FY23 current account status will be published on the last working day of June 2023. In a sense, the Q3FY23 CAD restores the sanity of June quarter after current account deficit had almost doubled in the September 2022 quarter. 

Quarter	Current Account Balance
Quarter Ended March 2020	$0.58 billion
Quarter Ended June 2020	$19.79 billion
Quarter Ended September 2020	$15.51 billion
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	$(18.20) billion
Quarter Ended September 2022	$(30.90) billion
Quarter Ended December 2022	$(18.20) billion

Data Source: RBI

There have been two positives for the current account situation in the December 2022 quarter. The current account deficit compressed back to June 2022 levels of $18.2 billion or 2.2% of GDP. That is a lot more comfortable, largely thanks to a narrowing merchandise trade deficit as well as a sharp surge in the services surplus. September 2022 quarter had been a double whammy with a sharply wider trade deficit in goods.

Two things favoured the current account situation in December 2022 quarter. Merchandise trade deficit tapered amidst falling commodity prices and slowing imports. Also, the services exports gathered momentum to the extent that overall deficit of goods and services was almost neutral in last few months. That has been a game changer for the current account deficit in India. A wider current account deficit has negative implications for the rupee value and the sovereign ratings outlook. 

How current account deficit narrowed sharply in Q3FY23

For the December 2022 quarter, the current account deficit narrowed sequentially from $30.9 billion to $18.2 billion. The December 2022 CAD is back to the June 2022 levels. In percentage terms, the CAD for Q3FY23, at 2.2% of GDP, looks a lot less intimidating than 4.4% CAD in September 2022 quarter. December 2022 marks the 5th successive quarter of current account deficit. Here are key triggers for narrowing current account deficit in Q3.

1. Firstly, the merchandise trade deficit narrowed sequentially from $(83.5) billion in the September 2022 quarter to $(72.7) billion in the December 2022 quarter. This was largely on account of lower commodity prices and weak import numbers. However, yoy current account deficit is still sharply higher for Q3FY23.

    

2. What is more interesting is that the POL (petroleum, oil, lubricants) accounted for 45% of the overall merchandise deficit for December 2022 compared to around 40% in September 2022. Effectively, there has been a sharp fall in the non-oil imports in the quarter including fertilizers, coal, ores, gold, silver, alloys, and chemicals.

    

3. The big story in December 2022 quarter was the growth in services surplus. It has grown from $31.1 billion in Q1FY23 to $34.4 billion in Q2FY23 and further to $38.7 billion in Q3FY23. The services surplus has grown incrementally in the last few months to almost wipe out the negative impact of the merchandise trade deficit.

    

4. Primary outflows on account of payments on investments in the form of interest and dividends widened sharply from $9.30 billion in Q1FY23 to $12.7 billion in Q3FY23, with most of the growth coming in the second quarter. This is on account of larger pay-outs on in-bound investments.

Overall, the trends from the CAD story appear to be positive for the December 2022 quarter. The current account deficit for the third quarter has narrowed sharply. The current account deficit for the full year may now be well under $100 billion or even under $90 billion. That is evident in the rupee holding Rs83/$ levels despite limited intervention from the RBI in the spot dollar markets.

Breaking up the CAD of $18.2 billion for Q3FY23

If FY21 reported a small surplus in the current account and FY22 had a deficit, then FY23 is likely to see a much wider current account deficit. FY23 CAD could end up below 3% of GDP and that is good news. Despite the crisis, CAD is still well under control.

Pressure on Current Account (CA)	Amount	Boosting the Current Account (CA)	Amount
Q3FY23 Trade Deficit	($72.70 bn)	Q3FY23 Services Surplus	+$38.70 bn
Primary A/C – Interest	($12.70 bn)	Secondary Income	+$28.50 bn
Negative Thrust on CA	(-85.40 bn)	Positive Thrust on CA	+$67.20 bn
		Current Account Deficit	(-$18.20 bn)

Data Source: RBI

The two factors that determine the final CAD are the trade deficit and the services surplus and both are moving favourably direction for India. The other items tend to even out. 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 $90 billion to $100 billion. That would be less than 3% of GDP, a far cry from the rather intimidating situation we saw at the end of the September 2022 quarter.

For real cues on CAD, look at the overall deficit

The trade deficit for FY23, originally pegged at $300 billion, may end up around $270 billion. That is higher than last year, but a lot more manageable. Here is a quick view of overall deficit combining services and merchandise trade as a proxy for current account deficit.

Particulars	Exports FY23 ($ bn)	Imports FY23 ($ bn)	Surplus / Deficit ($ bn)
Merchandise trade	$405.94 bn	$653.47 bn	$(-247.53) bn
Services Trade #	$296.94 bn	$164.00 bn	$+132.94 bn
Overall Trade	$702.88 bn	$817.47 bn	$(-114.59) bn

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

The overall trade deficit, is a combination of the merchandise trade deficit and services trade surplus. It had fallen from $(118.12) billion in December 2022 to $(111.94) billion in January 2023 and has marginally widened to $(114.59) billion in February 2023. That raises hopes of overall deficit closer to $115 billion, with less of a challenge to CAD. 

Effectively, that will translate into CAD of under 3% of GDP. That is still high, but not as bad as the 4.5% CAD for FY23, that was suggested by the September 2022 CAD data. The government gave a special boost to exports in recent months, but global headwinds still prevail. However, the current account deficit should be largely in control in FY23

What is the ideal policy response?

To be fair, the government has already undertaken a two pronged approach to bring the CAD under control. On the one hand, it is encouraging 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 surely helped matter.

RBI has a dilemma on hand. If RBI refuses to hike rates, imported inflation will widen the current account deficit as the rupee weakens. With the RBI repo rates touching 6.50%, the terminal rates are now looking above the 7% mark. The banking crisis may make the RBI more sober on rate aggression. Already cost of funds are hit, but any reversal could spur imported inflation. RBI surely has a tightrope walk on hand.