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Higher services’ surplus offset double-digit merchandise deficit

* India’s current account deficit (CAD) widened to USD36.4b (or 4.4% of GDP) in 2QFY23, marking the highest CAD in nine years (Exhibit 1). In a rare occurrence, 1QFY23 CAD was revised down to USD18.2b (or 2.2% of GDP) from USD23.9b (or 2.8% of GDP). The widening deficit in 2Q was on account of a double-digit merchandise trade deficit, which was partly offset by a sharp improvement in services’ surplus (Exhibit 2).

* Notably, India’s CAD excluding gold stood at USD26.6b (or 3.2% of GDP) in 2QFY23, surpassing the previous worse of 3% of GDP in 3QFY13 (Exhibit 3). Similarly, the current account surplus excluding gold and petroleum products was just USD8.6b (or +1% of GDP) during the quarter, resulting in the lowest surplus on record. This confirms that the worsening of CAD was broad-based.

* At the same time, India’s foreign capital inflows amounted to just USD6.9b in the quarter, down from USD22b in 1QFY23 and USD39.6b in 2QFY22. Net FDI flows were just USD6.4b in 2QFY23, augmented by FPI inflows of USD6.5b v/s net outflows in the previous three quarters. Accordingly, there was a drawdown of foreign exchange reserves (FXR) to the order of USD30.4b in 2QFY22 (or 3.7% of GDP), marking the highest drawdown since the 2008 Great financial crisis in 3QFY09 (Exhibit 4).

* A sharp rise in India’s CAD suggests a commensurate fall in India’s gross domestic savings (GDS) as investments failed to match the rise in CAD. Our calculations suggest that India’s GDS fell to 28.3% of GDP in 2QFY23, lower than 28.6% in 1Q and 32.4% of GDP a year ago in 2QFY22. In fact, GDS in 2QFY23 was the lowest in almost 18 years, barring 1QFY21 (Exhibit 5).

* We believe that the worst in terms of CAD is behind us. Although CAD is expected to remain high (3-3.5% of GDP) in 3QFY23, it may moderate quickly to ~2% of GDP in 4QFY23. With lower-than-expected CAD in 2QFY23 (and downward revision in 1Q), we revise down our FY23 CAD forecasts to 3.1% of GDP from 3.6% forecasted earlier (Exhibit 6).

* India’s CAD now stands at 3.3% of GDP in 1HFY23, compared to a small deficit of 0.2% of GDP in 1HFY22 and a surplus of 3% of GDP in 1HFY21. Although merchandise deficit has doubled in 1HFY23, the surplus on invisibles account (i.e., services + income) increased ~28% YoY to 5.5% of GDP (Exhibit 7). Importantly, however, foreign capital flows dried up in 1HFY23, leading to a drawdown of USD25.6b in India’s FXR 1HFY23, compared to an accretion of USD61.8b in 1HFY22. Notably, the total fall in India’s FXR was USD74.6b in 1HFY23, almost two-thirds of which was accounted for by the adverse valuation effect (reflecting the appreciation of the USD against major currencies and higher bond yields).

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