External sector outlook is benign

The strong BoP surplus of $32 billion in the June quarter was led by bigger capital flows and a current account surplus of $6.5 billion—0.9%of GDP.

Taper tantrums notwithstanding, the country’s external sector should not face any pressure this year. To be sure, there could be some slowdown in portfolio flows both into the bond and equities markets, but FDI should maintain its good run and we could see at least $35-36 billion coming in. No doubt, the trade deficit will widen as the domestic economy picks up pace; case in point is the September deficit of nearly $23 billion. But that is an outlier and, given exports are on a roll, the deficit should come in closer to $160-$180 billion. Much, of course, depends on where the price of oil settles. Also, supply-side shortages could continue to disrupt businesses and trade, but the $638 billion worth of forex reserves should cushion any discomfort.

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Indeed, the current account deficit is expected to be contained within $40 billion, assuming the price of crude oil doesn’t spike beyond $90 per barrel. As such, the balance of payments should see a surplus in the region of $44 billion. Importantly, the currency, barring any unforeseen events, is not expected to weaken beyond 75.50 to the dollar in the near -term.

The strong BoP surplus of $32 billion in the June quarter was led by bigger capital flows and a current account surplus of $6.5 billion—0.9%of GDP. The bigger current account surplus—vis-a-vis Q4FY21—resulted from a moderation in the trade deficit to $30.7 as also an increase in net receipts from services to $25.8 billion. Indeed, the smart jump in services—up 17% over the June 2019 quarter— thanks to good performance by software and remittances, would have to be the highlight of the season. At $197.1 billion for the April-September period, exports jumped 57% year-on-year and 24% over the corresponding period of FY20, surpassing expectations. True, they are plateauing at $33-35 billion a month after the big jump in March, but, even if global demand is seen to be tapering off somewhat, $380-390 billion for the year doesn’t seem out of reach.

On the capital front, there is bound to be some nervousness in the markets in the next couple of months since the US Fed has indicated it may begin the taper process as early as in November and the BoE appears to be readying for a rate hike in December. The ECB has already cut back on some bond purchases with inflation moving up. To be sure, the US is unlikely to rush the process and will more likely take calibrated steps, making sure the nascent and uneven recovery is not hurt. Indeed, flows into the relatively strong Emerging Markets (EM) should not slow significantly since money will chase yields.

Capital flows rebounded in Q1FY22 to $25.8 billion on the back of strong FDI and positive banking capital though FPI flows were modest. Given how dull FPI flows have been this year, the level of FDI would be important; these are estimated at a slightly lower $35 billion compared with $44 billion last year. FPI flows into the equity markets this year have been muted at just $1.2 billion compared with a strong $37 billion last year. The bond markets saw outflows both in FY21 and FY20, and this year too purchases have been small at just $2.1 billion. Although the dollar is expected to remain strong, the rupee is tipped to rule in the range 73.30–75.50, barring unforeseen events. While there could be some bouts of volatility, the markets should soon get over the disappointment of India not making it yet to a global index.