Current priorities- BoP is robust and prospects comfortable; low CAD undercuts efforts to create “virtuous investment cycle”

Current priorities: BoP is robust and prospects comfortable; low CAD undercuts efforts to create “virtuous investment cycle”

India’s current account deficit (CAD) narrowed to 1% of the GDP in the second quarter of the current fiscal year from 1.1% in the previous one, and a bloated 3.8% in the year-ago period, according to the balance of payments data released by the Reserve Bank of India recently. Though the deficit is expected to widen moderately in Q3, analysts feel it would still come in at an eminently manageable level of 1.3-1.4% for FY24, compared with 2% in FY23. Such a lower deficit, however, isn’t necessarily good news at the current juncture, when the economy is believed to be on the cusp of an investment cycle. India is a net borrower from the external world and needs foreign savings in considerable measure to finance fixed asset creation. The reliance on foreign capital is even more important for the country now, as domestic savings have plunged headlong. Net financial savings of households fell to a 49-year low of 5.1% of the GDP in FY23, the RBI had reported earlier.

India’s policymakers have been betting on a (still elusive) “virtuous cycle” of investments, where elevated public capex would crowd in private capital and bolster the economy’s productive capacity. They believe that the global environment is conducive to higher capital inflows into India, with “flush liquidity looking for investment avenues.” The latest set of BoP data, however, also reveals a significantly weaker capital account, with muted FDI and FPI inflows in Q2FY24. Loans and fresh deposits by foreign banks in their Indian counterparts are what helped the country in the quarter to bridge the (benign) CAD. While the current account balances in the first and second quarters of the current fiscal year were closely comparable, accretion to foreign exchange reserves declined sequentially by a tenth to just $2.5 billion in Q2.

The external sector is unlikely to turn precarious for India even if the US Fed defers the much-expected rate cut beyond March. India’s inclusion in the JP Morgan bond index too might spur capital inflows. That said, it must be noted that foreign capital—even FDI—doesn’t invariably mean assured greenfield investments (part of these are merely added to the reserves for subsequent investments in foreign securities). The CAD, being borrowed from foreign savings, is a closer proxy of investments, than capital inflows. While subdued exports have kept the goods trade deficit high in the first three quarters of FY23, services exports and remittances are buoyant. The policy focused on import substitution and the jump in the purchase of discounted Russian oil prevented imports from spiralling. Signs of a new capex cycle have been visible lately with companies importing machinery, intermediate goods, and electronic components for investments/value-added exports. Higher external commercial borrowings—up 77% to $22 billion in April-October—is another indicator.