India Equity Research: Motilal Oswal: INDIA ECONOMICS: 1QFY11 Balance of Payments

INDIA ECONOMICS: 1QFY11 Balance of Payments - Saga of trade gap funded by capital flow continues; no worries yet

RBI’s balance of payments (BoP) data release indicated steady overall surplus for 1QFY11. While trade deficit widened and net invisible surplus was lower than expected, capital flows remained well in excess of current account deficit in one of the most difficult quarters for external environment. 1QFY11 figures are broadly within our estimates and we do not see any immediate source of external vulnerability.

- Trade deficit widened to US$34b which is somewhat higher than the recent trend but lower than the peak of US$39b reached during 2QFY09. Similarly, as a proportion of GDP the trade deficit was high at 9.8%, but lower than the peak of 13.7% in 2QFY09 and the more recent 10.3% in 2QFY10.

- However, invisible surplus at US$ 21b remained somewhat below our expectations. While the invisible receipts registered healthy growth (US$26b in 1QFY11 vs US$21b in 1QFY10), invisible payments too grew (US$16b vs US$11b in 1QFY10) negating much of the gain made from the upturn in software and business services exports.

- As a result, the current account deficit peaked to US$14b (from US$13b in 4QFY10 and US$5b in 1QFY10). At 3.9% of GDP, the current account deficit widened but was lower than the high of 4.4% of GDP in 2QFY09.

- Capital flow exceeded expectations with net inflow of US$18b, one of the highest in recent times, although much lower than the pre-crisis peak of US$33b in 2QFY08. This resulted in an overall balance of payments surplus of US$4b, equivalent to net accretion in foreign exchange reserves.

Overall balance of payments situation healthy despite higher trade deficit

	1QFY10	2QFY10	3QFY10	4QFY10	1QFY11	FY09	FY10	FY11E
In US$ B
Trade Deficit	-26	-29	-31	-31	-34	-119	-117	-140
Invisible Surplus	21	20	19	18	21	90	79	101
Current A/c deficit	-5	-9	-12	-13	-14	-30	-38	-39
Net capital flow	4	19	15	16	18	9	52	50
BoP Surplus	0	10	3	3	4	-20	13	11
As % of GDP
Trade Deficit	-9.5%	-10.3%	-9.3%	-8.9%	-9.8%	-9.7%	-8.9%	-9.3%
Invisible Surplus	7.9%	7.2%	5.6%	5.2%	5.8%	7.4%	6.0%	6.7%
Current A/c deficit	-1.7%	-3.1%	-3.6%	-3.7%	-3.9%	-2.4%	-2.9%	-2.6%
Net capital flow	1.5%	6.7%	4.4%	4.6%	5.2%	0.5%	4.1%	3.2%
BoP Surplus	-0.2%	3.5%	0.7%	0.9%	1.3%	-1.8%	1.2%	0.6%

- It is noteworthy that the above performance comes in one of the most challenging quarters of external environment for Indian trade. The quarter witnessed major concerns of Eurozone sovereign debt crisis and concerns of double dip recession impacting the Western economies.

- Also, World trade is just beginning to turn up and India is likely to be a beneficiary of this trend, especially for its software and business services exports which have turned up even in a difficult quarter.

- Net capital flow has much exceeded our expectations and current data in this respect indicates stronger momentum in gross flows.

- We expect the external situation would come up well in 2QFY11 based on the above factors and at the current run rate various BoP indicators are within our FY11 estimates. Hence, we do not see any immediate cause for concern barring renewed adverse development in the external conditions, the risk of which has receded substantially.

Higher trade gap met by invisible surplus & capital flows BoP indicators have remained stable (% of GDP)

Rupee to reflect BoP position given RBI’s non-intervention

- During YTDFY11, largely depreciating trend in Rupee was reversed during September due to heavy capital flow during the month. This has led the nominal Rupee to remain broadly unchanged vs USD although reflecting the rise of Yen and GBP (June onwards) it depreciated against them. Again, the strong recovery of Euro during September was reflected in a depreciation of the Rupee vis-à-vis Euro during the month. As India’s balance of payments position was evenly balanced, Rupee largely followed the cross-currency movement during H1FY11.

- So far, RBI has not been intervening in the forex market, resulting in Rupee appreciating in real terms for a large part of FY11 due to large inflation gap between India and other western countries. An evenly poised BoP position and a non-intervening RBI have left the Rupee as one of the most flexible currencies in the world. This contrasts with the “currency war” (as officially pronounced by Brazil) waged by many countries of the world including most notably China, joined by Japan, Korea, Switzerland, etc.

- While we expect widening current account deficit to be largely met by capital flows, accretion to reserves would be relatively slow. This along with the fact of high inflation may lead RBI to finally intervene in the later part of the year to stem the Rupee and to meet the requisite money growth.

- We expect Rupee to continue to reflect two-way movement with a deviation of +/-Rs2 around INR/USD of 45. Our current estimate of average INR/USD is 46 for FY11 and 44.5 for FY12.

Broadly balanced BOP reflected in rupee tracking international cross-currency movement

							Change
Currency	31-Mar-10	30-Apr-10	31-May-10	30-Jun-10	31-Aug-10	30-Sep-10	Sep over Aug	Sep over Mar
INR/USD	44.92	44.37	46.37	46.45	47.08	44.95	-4.74%	0.06%
INR/YEN	48.44	47.25	50.78	52.61	55.96	53.70	-4.21%	10.86%
INR/GBP	68.03	68.31	67.33	70.07	72.64	71.14	-2.10%	4.57%
INR/EUR	60.56	58.94	57.17	56.94	59.50	61.00	2.46%	0.73%