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Current account back in deficit

* The current account finally reverted to a deficit of US$1.7bn (-0.2% of GDP) in Q3FY21 from a surplus of US$15.1bn (2.4% of GDP) in Q2FY21, driven by a widening in trade deficit, while the services surplus saw an improvement. Nonetheless, the material improvement in capital account in Q3FY21 led to a record-high BoP surplus of US$32.5bn. The large capital account surplus was boosted by robust net FPI equity flows of US$22bn. Although FPI flows moderated sequentially, they remained strong at ~$17bn. The basic balance (CAD+FDI), which reflects durable current account funding, sharply moderated to US$15.2bn from a whopping US$40.1bn in Q2FY21.

* Going ahead, even as current account surplus will narrow further as domestic and global economies normalize, it will still likely to be in a surplus of 0.9% of GDP in FY21 amid a comfortable funding environment, implying FY21 BoP surplus of ~US$90bn. However, the best seems to be over on external sector comfort. A gradual recovery means import growth will exceed export growth, while higher losses in oil led terms of trade imply current account/GDP to return to a deficit of ~0.8%. However, healthy capital flows should ensure FY22E BoP remains in surplus of US$52bn.

* Net positive BoP dynamics should help keep a mild upward bias on INR vs. USD but the overall trajectory of INR will be caught between mixed external sector terms of trade, gradually changing global risk environment and RBI stance on FX. We see USD-INR in the range of 71.50- 75.50 in FY22.

Q3FY21 current account turns into deficit on higher trade deficit

After posting a surplus in the previous three consecutive quarters, Q3FY21 current account finally gave way to deficit, printing (-)US$1.7bn (-0.2% of GDP) vs. a surplus of US$15.1bn (2.4% of GDP) in Q2FY21 and US$2.6bn deficit (0.4% of GDP) a year ago. The sequential move toward CAD was primarily due to higher merchandise trade deficit of US$34.5bn (4.7% of GDP) vs. US$14.8bn (2.3% of GDP) in the preceding quarter, caused by a sharp rise in imports over exports stemming from higher oil prices and improving domestic demand. Imports rose to US$111.8bn (US$90.4bn in Q2FY21), while exports inched up marginally by US$1.6bn (QoQ) to US$77.2bn in Q3FY21. Turning to invisibles, net services receipts increased both sequentially and on a year-on-year basis, primarily on the back of higher net export earnings from computer services. Net remittances increased a tad to US$19.3bn. However, net income drag worsened further to (-) US$10.1bn from (-)US$9.3bn

Q3FY21 capital account bloats on FPI equity flows, leading BoP to super surplus

The material sequential improvement in capital account in Q3FY21 (US$33.5bn; 4.5% of GDP) from Q2FY21 (US$15.4bn; 2.4% of GDP) was largely due to robust equity FPI flows which largely picked pace in early November, FPI debt flows improved a tad. FDI flows moderated but remained healthy at US$17.0bn (US$24.6bn in Q2FY21). Other debt inflows like ECBs and banking capital continued to see outflows. ECB outflows stood at (-) US$1.7bn, down from (-)US$4.3bn in Q1FY21 with repayments exceeding fresh disbursals, while net accretions to NRI deposits increased to US$3.0bn from US$1.9bn in the previous quarter. Overall, BoP surplus in Q3FY21 remained high at US$32.5bn (US$31.6bn in Q2FY21). The basic balance (CAD+FDI), which reflects durable current account funding, moderated sharply sequentially to US$15.2bn from a whopping US$40.1bn in the prior quarter.

FY22 current account to reverse into 0.8% deficit amid normalization and oil effect

High-frequency external sector data imply Q4FY21 current account deficit will likely worsen further. Nonetheless, overall exports recovery for FY21 may still outdo that of core imports. We see FY21 current account/GDP at a surplus of 1.1% (US$28bn), which would be led by huge terms of trade gains from a slump in oil imports while core import demand is still sluggish. Net funding remains comfortable amid stilleasy global liquidity, with FY21 BoP in surplus of ~US$96bn, helped by lower current account as well as solid FPI and FDI flows. As we move into FY22, a gradual recovery implies import growth will exceed export growth, while higher losses in oil led terms of trade will imply current account/GDP to return to a deficit of ~0.8%. However, healthy capital flows will ensure FY22E BoP remains in surplus of US$52bn.

Ideally, positive BoP dynamics should help keep a mild upward bias on INR vs. USD, especially as global liquidity continues to chase carry in EM economies albeit selectively. However, global winds may imply foreign investors start asking for a higher risk premium from EM and could start pressurizing EM assets, including India. We note India’s real rates are negative and one of the lowest in the EM pack. Besides, continued tactical intervention by the RBI will ensure the INR remains somewhere in the middle of the EM pack in terms of spot returns. Overall, the INR’s performance will be caught between mixed external terms of trade, gradually changing global risk environment, RBI stance on FX and fiscal fragilities.

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