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Widening deficit reflects both seasonality and demand normalization

* Mar’21 merchandise trade deficit widened to USD 14.1bn, driven by smart sequential gains in both exports and imports. The annualized print of exports and imports benefited from the low base effect, which will likely continue until Jun’21. Exports (ex-oil) and core imports surged 62% and 46% yoy, respectively. For FY21, the trade deficit came in at USD 99.3bn (-39%yoy), with exports and imports contracting 6.1% and 15.8%, respectively.

* In our view, the current account deficit will widen further in Q4FY21 but it will still likely be in a surplus of 0.9% of GDP in FY21, with comfortable funding environment implying FY21 BoP in a surplus of ~USD90bn. However, the best seems to be behind us on the external account. A gradual recovery would imply that import growth is likely to exceed export growth, while higher losses in oil-led terms of trade would mean that the current account-to-GDP ratio will return to a deficit of ~0.8%. However, healthy capital flows should keep FY22E BoP in a surplus of USD 52bn.

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

Trade deficit widens further to USD 14.1bn in Mar’21

As per the prelim estimates, Mar’21 merchandise trade deficit widened to USD 14.1bn from USD 12.6bn in Feb’21. Sequentially, both exports and imports rose significantly, hitting their all-time highs in value terms at USD 34bn and USD 48.12bn, respectively. On a yoy basis, both exports and imports benefited from the low base effect, with exports and imports rising 58.2% and 52.9%, respectively, in Mar’21. The low base effect will continue to influence growth rates until Jun’21. For FY21, the trade deficit came in at USD 99.3bn (-39%yoy), down from USD 161.4bn in FY20.

Strong export growth led by engineering goods and gems and jewelry

Amid 58.2% yoy growth in exports, both oil and non-oil exports were higher. Oil exports rose by 27.4% in Mar’21 vs. 27.1% contraction in Feb’21, partly reflecting higher prices. Meanwhile, non-oil exports rose 62.3% yoy in Mar’21 vs 3.7% growth last month. Within non-oil exports, the rise was reported in engineering goods (70.3%), gems and jewelry (75.6%) and pharma (47.4%). We note that the uptrend in Pharmaceuticals has continued and could remain buoyant as India is likely to keep exporting vaccines globally through 2021 and 2022, helped by affordable vaccine production back home. The consistent growth in iron ore exports (194.9%) is fuelled by good demand from China, which accounts for ~90% of India’s exports in iron ore. In FY21 exports declined 7.4% (USD 290.2bn).

Core imports lead the show for import’s impressive growth

The 52.9% yoy growth in imports (7.0% in Feb’21), while led by the low base, saw core imports dominating the show. Non-oil non-gold imports rose for the fourth consecutive month and were up 46.3% yoy in Mar’21 (6.1% prior), growing sequentially by 12.5%. Electronic goods imports were higher by 76.7% yoy (21% mom) and capital goods imports by 13.5% yoy (-12% in Feb’21). Imports of gold continued to surge, recording growth of 584% yoy (124% earlier), driven by the volume and price effect. Oil imports were up 1.2% YoY (-16.6% in Feb’21), reflecting the base effect as well as the rise in crude oil prices.

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

High-frequency external sector data imply that the Q4FY21 current account deficit will likely worsen further. Nonetheless, overall export recovery for FY21 may still outdo that of core imports. We see FY21 current account-to-GDP ratio at a surplus of 1.1% (USD 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 still-easy global liquidity, with FY21 BoP in a surplus of ~USD96bn, helped by lower current account as well as solid FPI and FDI flows. As we move into FY22, a gradual recovery implies that import growth will exceed export growth, while higher losses in oil-led terms of trade would mean that the current accountto-GDP ratio will return to a deficit of ~0.8%. However, healthy capital flows will ensure that FY22E BoP remains in a surplus of USD52bn. Despite a BoP surplus, continued tactical intervention by the RBI will ensure that INR remains somewhere in the middle of the EM pack in terms of spot returns. Overall, INR performance will be caught between mixed external terms of trade, gradually changing global risk environment, RBI’s stance and also fiscal fragilities.

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