Despite peaking of CAD tailwinds, the outlook remains uncertain

The country’s current account deficit widened in Q1 led by a widening of the goods trade deficit and moderating services surplus. However, capital account surplus surged, aided by healthy FPI inflows and banking capital. Still, it trailed analysts’ forecast riding on a healthier than anticipated merchandise trade balance, even as the services trade surplus and balance of secondary income were lower than anticipated. Analysts expect CAD to widen to 1.6 per cent in July 2023-March 2024 with BOP in a deficit of $23.5 bn. The Q1 CAD widened to $9.2 bn or 1.1 per cent of GDP. This was mainly led by widening of the non-oil goods trade deficit to $32 bn. Net invisible inflows fell to $seven billion, amid a moderation in services surplus. Personal travel pulled down services net exports the most, in all probability a seasonal effect. Software and professional and management consulting services have remained steady from the previous quarter. Of course, capital account surplus in Q1 surged to $34 bn, aided by healthy FPI inflows in equities, whereas FDI inflows remained tepid. Furthermore, banking capital inflows also increased sharply to $13 bn from the net outflow of $four billion in the preceding quarter. ECBs increased to $six billion-the highest in nine quarters.

Consequently, BOP surplus in Q1 surged to $24.4 bn. Forex reserves in Q1 increased by $16.6 bn, which included a valuation effect of $7.8 bn. According to Kotak Institutional Equities, BOP is expected to have peaked in Q1 and the remainder of the current fiscal to be clouded with uncertainties, amid rising crude oil prices and weak capital flows. Following a robust 1Q, analysts expect the capital account to moderate to $23 bn in July 2023-March 2024, taking the current fiscal’s capital account to $55 bn. In fact, they have revised up their current year’s CAD estimate to 1.5 per cent, with the July 2023-March 2024 CAD estimate at 1.6 per cent with a further upside to our estimates, if crude oil prices persist at current levels.

On the forex front, one can expect the INR to remain under pressure, amid the unrelenting US dollar strength and rising crude oil prices stemming from OPEC+ production cuts. Though FPI inflows from inclusion in the global bond index are likely to aid the INR in the medium term, the corresponding risks from the global side are likely to dominate and keep INR under pressure over the near term. In this scenario, RBI’s intervention is expected to stem any likely volatility in the INR. It is also possible that the INR will trade in the range of 82.75-83.50 over near term, with a further depreciation bias. With the average merchandise trade deficit trending higher in July-August relative to Q1 levels, and the recent rise in crude oil prices, analysts estimate that the CAD would widen sequentially to $19-21 billion or -2.3 per cent of GDP in Q2.