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Economy
2QFY11 BoP: Saved by the robust FII inflows. India’s current account deficit (CAD)
widened to a record US$15.8 bn or 4.1% of GDP in 2QFY11. This was largely in line
with our expectations (Kotak estimate US$16.5 bn). The bigger surprise came from the
modest US$20.5 bn capital inflows, despite a US$18.8 bn of FII inflows. With the
persistent deterioration in the CAD and combined now with the weakness in other
capital flows, there is a risk to India’s balance of payments. We expect BoP surplus to
remain modest in FY2011E as well as FY2012E.
CAD concerns remain alive
CAD widened sharply to a record US$15.8 bn, significantly higher than the US$9.2 bn deficit seen
in 2QFY10. While 1Q CAD was revised down to US$12.1 bn from the earlier US$13.7 bn, the 1H
deficit at US$27.9 bn is more than double that seen in 1HFY10 (US$13.3 bn). The sharp
deterioration of the CAD was driven by the continued widening of the trade deficit as imports
outpaced exports together with stagnation in net invisible receipts. Invisible receipts have been
hurt as the persistence of low interest rates globally has resulted in a sharply deceleration in
investment income, while private transfers have also slowed down. On the other hand, higher
payments for business, travel and other services have seen invisible payments rise sharply.
Capital inflows other than Portfolio flows and ECBs falter
Net capital inflows rose to US$20.5 bn from US$16.2 bn in 1QFY11 and US$19.3 bn in 2QFY10.
However, portfolio flows at US$19.2 bn accounted for close to 94% of this, with ECB inflows
adding another US$3.7 bn. FDI inflows, as also short-term borrowing, were rather subdued while
banking capital surprisingly declined as commercial banks built up their foreign assets.
BoP on a knife-edge though no immediate risks seen
BoP surplus for the economy in 2QFY11 shrunk to only US$ 3.3 bn compared to US$ 9.4 bn in the
same quarter of last year. While we do not see any immediate risks from the BoP position, the
potential problem comes from the fact that the capital account surplus has become significantly
reliant on large FII flows that are intrinsically volatile in nature. Precipitation of any severe riskaversion out of the European sovereign debt problems could, however, lead to significant
volatilities in the currency market. We expect the current account deficit as a proportion of GDP to
moderately correct in FY2012E to 3.2% compared to 3.4% in FY2011E. However, it is still, in our
opinion, remains significantly wide and heavily dependant on the FII flows for financing
CAD increases to US$15.8 bn in 2QFY11 from US$12.1 bn in 1QFY11
The risks to the Balance of Payments that had been flagged off as one of the key risks to
India continue to play itself out with an increase in the current account deficit for the second
quarter of the financial year. Incidentally, the current account gap for the 2QFY11 is now at
4.1% of GDP, a sharp rise from the 3% of 1QFY10. For H1 of the current financial year,
CAD is at US$27.9 bn compared to US$13.3 bn in the similar period last year.
The key reasons for the sharp rise in the CAD were a combination of both higher trade gap
and lower invisible receipts:
1. Exports grew at a rate higher than imports in the quarter but in absolute terms the
trade deficit widened to US$35.4 bn as compared to US$29.6 bn in the same
quarter of last year.
2. Net invisible receipts in 2QFY11 were at US$19.6 bn, down from US$20.4 bn in the
same quarter of last year. This decline was supported by a surprise drop in the
private transfers. Investment incomes also came off sharply on account of lower
interest rates abroad and are also expected to continue in the same fashion.
Investment income in 1HFY11 is at US$-6.1 bn compared to US$-3.0 bn in 1HFY10.
3. Software exports held ground in the midst of a volatile global environment and
actually registered a rise to a net inflow of US$12.2 bn in 2QFY11 from US$10.8 bn
in the same quarter last year.
Risks of persistence of wide current account gap remains
We continue to see current account gap remaining wide for the rest of the year, albeit
expecting some correction from the 4.1% of GDP mark that was seen for the latest reported
quarter. The factors that have guided the widening of the current account gap in 1HFY11
are expected to play itself out in the rest of the FY.
• As per the DGCIS data, exports appear to have shown some improving trends. This,
however, could be on account of some festive demand that might not sustain in
the remaining part of the FY. On the other hand, oil prices and prices of other
imported commodities have moved higher, that is likely to boost the import
payments on these items. With growth expected to stay robust, import payments
on account of capital goods could also stay strong.
• On the other hand, while software services sector growth can continue to grow,
the pace of accretion in receivables under this head had been lower and could
continue in a similar fashion, given the lack of adequate pull from the global
economies.
• The drag from the non-software services could also continue. Further investment
income is expected to underperform as interest rates in the rest of the world are
expected to persist at low levels.
Surpluses under capital account remain healthy
Overall surpluses under the capital account in 2QFY11 remained healthy at US$20.5 bn
compared to US$19.3 bn in the same quarter of last year. 1HFY11 surplus on capital
account is at US$36.7 bn compared to US$23.0 bn in 1HFY10. However, some critical points
are in order:
1. Net FDI into India dropped off sharply to US$5.3 bn in 1HFY11 compared to
US$12.3 bn of 1HFY10. While the out-bound FDIs were at US$7.3 bn in 1HFY11,
they were at US$ 7.4 bn in 1HFY10. However, the inbound FDIs dropped sharply by
around US$ 7 bn between the 1H of this fiscal and the last. RBI reports that
deceleration in FDI to India was mainly on account of lower flows under
construction, real estate, business and financial services. Country-wise there was
significant decline in FDI from Mauritius and Singapore.
2. Banking capital turned negative in 2QFY11 to US$-3.2 bn from US$4.4 bn in the
similar quarter of last year. This can be assigned to a build-up of foreign assets of
the commercial banks.
3. External commercial borrowings, however, remained healthy and jumped in
1HFY11 while short-term capital flows had also been improving in the current FY
on account of a rise in the imports.
4. However, the major component under the capital accounts remains the volatile
flows under the FII head. Net portfolio inflows into the economy in both debt and
equity almost doubled to US$19.2 bn during the quarter from US$9.7 bn in the
same quarter of last year.
BOP on a knife-edge, no immediate risks seen
BoP surplus for the economy in 2QFY11 shrunk to only US$3.3 bn compared to US$9.4 bn
in the same quarter of last year. The low BoP surplus explains why the RBI had not been able
to intervene in the currency markets even when USD-INR was on an appreciation bias. While
we do not see any immediate risks from the BoP position, the potential problem is from the
sources of the capital account. The capital account surplus has become significantly reliant
on large FII flows that are intrinsically volatile in nature. To put it in perspective, net FII flows
at US$19.2 bn in 2QFY11 were 94% of the total capital account surplus for the quarter. In
1QFY10 the comparable figure was at around 50%.
The above highlights the knife-edge situation that we referred to. The reliance on volatile
flows has increased sharply, a risk that RBI has also highlighted in its recently released
“Financial Stability Report”, (December 10). We do not think that the issues in Europe have
been sorted out and any increase in the risk aversion in the global financial markets could
lead to outflows through the FII route and significant volatility in the currency markets.
We currently forecast (Exhibit 3) the current account deficit as a proportion of GDP to
moderately correct in FY2012 compared to FY2011. However, it still, in our opinion remains
significantly wide and heavily dependant on the FII flows for financing.
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