Dull capital flows and the expected widening of the current account deficit (CAD) caused the BOP (balance of payments) to moderate somewhat sharply in the March quarter, with the accretion to the reserves at just $3.4 billion. Nonetheless, the BoP surplus for FY21 was a robust $87.3 billion, the biggest in a long time. It helped that crude oil prices averaged about $45/barrel, the lowest in five years, and also that imports remained compressed. The surplus in the current account, of $24 billion, and the smaller capital account surplus, of $64 billion, must be seen against the backdrop of economic activity having been sluggish for the better part of the year.
India’s external sector has held up quite well against the adverse events of the past year. The strong build-up reserves, to around $600 billion, means the import coverage ratio is now at 12-13x, twice the levels seen during the taper-tantrum times of mid-2013. Moreover, the ratio of the total external debt to reserves is now 0.9, compared with 1.4. As economists point out, India is well-placed to deal with the reversal of the US Fed’s accommodative policy.
To be sure, the surplus in the BoP will come down to less than half of last year’s levels. The trade deficit will definitely increase as commodity prices—especially crude oil—stay elevated and non-oil, non-fuel imports pick-up on the back of a recovery. Unless they head well beyond $80/ barrel, however, the import bill should be manageable. The average monthly trade deficits could soon hit double-digits as vaccinations pick up and the busy season sets in. As against the surplus of 0.9% of GDP in FY21, the deficit in the current account for FY22 is pegged at anywhere between 1.1-1.6% of GDP, depending on where Brent rules.
The March quarter saw a small capital account balance, of $12 billion (about a third of the levels seen in December 2020). FDI inflows, at just $3 billion, were about a sixth of the flows in the December 2020 quarter. However, these tend to be lumpy, and the FY21 numbers were impressive. Net foreign portfolio inflows in Q4FY21 came in at $7 billion, a third of the levels seen in the December quarter. The capital account—primarily FPI flows—will, in the near term, be driven to some extent by the imminent tapering of US Fed’s asset purchases. However, unless the normalisation process in the US begins much earlier than the Fed has indicated, any big pullout of portfolio flows from India are unlikely. Economists estimate net capital inflows in FY22 in the region of $65-$70 billion.
It is important that exports do well this year and that the rupee—currently, at around levels of 75 to the dollar—doesn’t appreciate. As economists at DBS point out, currencies associated with sticky inflation and negative real rates ought to be facing depreciation pressure. However, so far, it has turned out to be quite the opposite, owing to a marked improvement in the BoP. Despite the ongoing economic sluggishness, the rupee would have appreciated substantially had it not been for the intervention by RBI. Should the rupee appreciate, it might leave exports short of the estimated $350 billion.