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Bracing for a sharp widening in FY23 CAD/GDP

* CAD narrowed in Q4FY22 to US$13.4bn (1.5% of GDP) from US$22.2bn (2.6% of GDP) in Q3FY22, led by a lower trade deficit, reflecting resilient exports, while the services surplus improved. This, combined with FPI outflows, led to a deficit in the capital account for the first time since the taper tantrum. After falling to near neutral in Q3, the implied BoP turned into a deep deficit of US$16bn. However, the basic balance (CAD+FDI), which reflects durable current account funding, reverted to positive territory, amid higher FDI. Overall, FY22 CAD/GDP stood at 1.2% vs. a surplus of 0.9% in FY21, while the BoP surplus nearly halved to US$47.5bn from FY21.

* We raise our FY23 CAD/GDP forecast to US$112bn (3.3% of GDP) from US$102bn (3.0%) amid worsening terms of trade with oil sustaining above USD110/bbl and other commodity pressure remaining intact. Capital account will remain tricky too, implying the BoP deficit may soar to US$61bn (US$47bn earlier forecast) vs. +US$47.5bn in FY22.

* The INR’s performance has been caught between worsening external terms of trade, a fast changing global risk environment, FPI outflows and the RBI’s FX stance. The recent strong intervention by the RBI in spot and forward has implied a sharp fall in FX reserves and decadal low forward premia. However, continuing with the same force for long will come with a cost. We believe eventually the RBI may let the exchange rate adjust to new realities, albeit orderly, letting it act as a natural macro stabilizer to policy reaction functions. We see USD-INR in the range of 77.50-79.00 in the near term.

Q4FY22 CAD/GDP narrows to 1.5%, led by lower trade deficit; FY22 CAD/GDP at 1.3%

The current account deficit narrowed in Q4FY22 to US$13.4bn (1.5% of GDP) from Q3FY22’s US$22.2bn (2.6% of GDP), though it widened vs. the year-ago print of US$8.4bn (1.0% of GDP). The sequential decline was led by a moderation in the trade deficit amid the resilience in exports and a lower net outgo of primary income. Turning to invisibles, net services receipts increased, both sequentially and year on year, on the back of robust performance of net exports of computer and business services. Net remittances were strong and steady at US$21.1bn. Net investment income drag much lower QoQ and YoY to (-)US$8.4bn. Overall, FY22 CAD/GDP stood at 1.2% vs. a surplus of 0.9% in FY21, led by a widening of the trade deficit to US$189.5bn from US$102.2bn a year ago. Net invisible receipts were higher in FY22 due to an increase in net exports of services and net private transfer receipts, even though net income outgo was higher than a year ago.

Q4 capital account and BoP in deep deficit; FY22 BoP sees accretion nearly halving from FY21

The material sequential weakness in capital account in Q4FY22 [(-)US$1.7bn; 0.2% of GDP] was largely due to consistent FPI (equity) outflows, while FDI strengthened to US$13.8bn from US$4.6bn (US$2.7 a year ago). The last time we saw a deficit in the capital account was in Q2FY14 – the summer of taper tantrums. Although ECB flows were back in the positive territory, they were still almost half of the same period last year, led by higher global interest rates. Overall, BoP turned into a deep deficit of US$16bn [+US$0.5bn in Q3, but with the basic balance (CAD+FDI)], reflecting durable current account funding being neutral vs. a deep deficit of US$18bn prior. For FY22, BoP saw an accretion of US$47.5bn (US$87.3bn in FY21), helped by healthy FDI, countering FPI outflows of US$15.2bn.

Raising FY23 CAD/GDP to 3.3%; BoP deficit to be above US$60bn

As we assess the macro impact of higher energy/agri/other commodity prices, we recognize that the uncertainty is high. Worsening losses in oil-led terms of trade would imply CAD/GDP could shoot up by 0.5% with each $10/bbl increase in crude prices. This takes into consideration both the negative (through higher net oil imports) and positive (through higher remittances) impacts. With oil sustaining above USD110/bbl and other commodity pressures remaining mixed, the CAD/GDP ratio may comfortably cross 3.3% of GDP in FY23E.

The pain would likely linger in the capital account. As global portfolios reassess positions amid financial tightening & recession fears and ask for higher EM risk premia, FPI (equity) flows will likely remain negative ahead, but we assume mild inflows in Q4FY23 as CY22 bears the front-loaded pain. On net, even if we assume FDI as sticky, we now see FY23 BoP deficit to soar to US$61bn (US$47bn earlier) vs. +US$47.5bn in FY22.

INR pressure to continue

The INR’s performance has been caught between worsening external terms of trade, a fast changing global risk environment and FPI outflows, and RBI’s FX stance. The recent strong intervention by the RBI in spot and forward has implied sharp fall in FX reserves and decadal low forward premia. However, continuing with the same force for a long time will come with a cost. In our view, eventually the RBI may let the exchange rate adjust to new realities, albeit orderly, letting it act as a natural macro stabilizer to policy reaction functions

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