India’s current account is likely to swing from an unprecedented surplus in 2020 back into deficit in 2021 as domestic demand rebounds and oil prices continue to recover. But when it does return, the deficit should remain small. And with capital inflows holding up well, the external position should remain secure for the foreseeable future.
- India’s current account is likely to swing from an unprecedented surplus in 2020 back into deficit in 2021 as domestic demand rebounds and oil prices continue to recover. But when it does return, the deficit should remain small. And with capital inflows holding up well, the external position should remain secure for the foreseeable future.
- India’s current account surplus narrowed from US$19.2bn (3.8% of GDP) in Q2 2020 to US$15.5bn (2.4% of GDP) in Q3. The data are volatile quarter to quarter. Taking a longer perspective of the year to Q3, the current account surplus rose from 0.4% of GDP to 1.3% of GDP, its largest on record. (See Chart 1.)
- Looking ahead, we doubt that the current account will remain in surplus for more than a few quarters. Preliminary trade data for December released over the weekend show that the goods trade deficit widened significantly last month. That was in part the result of a jump in imports as domestic activity continued its recovery. In addition, the import bill has been lifted by higher oil prices, which are likely to rebound further (our Commodities teams expect the price of Brent Crude to rise to $60pb by end-2021, from $51pb currently).
- Admittedly, exports should also pick up as the global economy continues to recover. But container shortages remain a headwind. India also has little to gain from stronger global demand for electronics and IT equipment from people shifting to working from home, which has been boosting demand in the rest of Asia. Electronics exports account for less than 5% of total goods exports, compared to 15-35% elsewhere in the region.
- In all, we think the current account will tip back into a small deficit of around 1.0% of GDP in 2021, and widen further to 1.5% of GDP in 2022. However, this would hardly be a matter of concern. It would be well within the RBI’s 2.0% of GDP threshold that it considers sustainable and much smaller than was the norm from 2010 to 2013, when the deficit averaged 4% of GDP. After all, even if oil prices do rise as we expect, they are likely to remain far below the levels from a few years ago.
- A shift in the composition of capital inflows over recent years adds to our belief that the external position won’t return as a source of vulnerability. FDI inflows – a relatively stable and long-term source of funding – rebounded in Q3 and remained significantly higher than volatile portfolio inflows. (See Chart 2.) And more timely data show that portfolio inflows also surged at the end of 2020, helped by positive news on the development of effective COVID-19 vaccines.
- Bringing all of this together, the external position looks secure for the foreseeable future. It therefore poses little threat to our view that, like most other currencies, the rupee will appreciate a touch against the US dollar over the coming years.
Chart 1: Current Account Balance
Chart 2: Net Capital Inflows
Sources: CEIC, Capital Economics
Sources: CEIC, Capital Economics
Shilan Shah, Senior India Economist, email@example.com