India: Uneasy Lies ahead

India’s current-account deficit in Q1 FY16 expanded to $6.2bn due to poor exports, which increased the merchandise trade deficit. The capital-account balance suffered from FII outflows. We expect Q2 to be more turbulent for the capital-account balance. Full recovery is not yet visible at the ground level, the inability of the Government to pass crucial reforms and expectation of the Fed rate hike are likely to push the rupee down in the months to come. Subsequently, we expect a major pull-back of the rupee and the market (in H2 FY16).   

 Performance. The Q1 FY16 CAD came in at $6.2bn (1.2% of GDP), up from the Q4 FY15 ($1.5bn). In Q1, the merchandise trade deficit widened to $34.2bn (vs. $31.7bn in Q4 FY15) and invisibles balance ($28bn) was lower due to software ($17.7bn) and workers’ remittances ($16.3bn). Outflows in portfolio investment ($2.3bn) led to the capital-account balance plummeting to $18.1bn (3.5% of GDP). FDI inflows ($10.2bn) climbed up for the third consecutive quarter. Banking capital jumped to $11bn (vs. $1.7bn). India’s accretion to foreign-exchange reserves was $11.4bn. 

Assessment. No major surprises were seen in the data. The CAD rose  from the previous quarter following the surge in crude-oil prices. Despite the low crude prices (Indian basket averaging $62/barrel for 1QFY16), the poor export figures counter-balanced the drop in imports. Apart from slow global-growth, the low crude price is affecting our export bill. Invisibles was lower on account of software services and private transfers. FII outflows (a seven-quarter low) brought down the capital-account surplus. The good numbers in FDI and banking capital (a volatile component) saved the day, and helped in accretion of forex reserves.    

 Outlook. FII outflows during Apr-Jun dragged down the capital-account surplus for the quarter. August, too, has seen large outflows. This is likely to further push down the capital-account surplus in the next quarter. With crude likely to persist at present levels, we do not expect major changes in the import bill. Some improvement however is expected on the back of growth recovery in the US and the euro-area.  The devaluation of the rupee would also help export growth to recover. For the year, we see the CAD at $24bn. Recommendation. With no surprises in the BoP data, markets are unlikely to react. However, the low capital-account figures would rouse unease. 

With no major pick-up seen at the ground level, the inability of the government to pass the Land and GST bill, FII flows are likely to be low in the months ahead. A hike in the Fed interest rate would be an added deterrent. The downward pressure on the rupee is likely to persist until clarity emerges regarding the interest-rate cycle in the US and India. Beyond that, we expect a pull-back of the exchange rate and the market in H2 FY16