As the Indian economy started to slowly slip back into normalcy during the quarter of July-September 2021, imports increased to meet pent-up demand and so did India’s trade deficit. The current account turned into a deficit from its positive balance in the earlier quarter. But, the deficit was easily manageable at 1.3 per cent of GDP.
The current account was in surplus during the second wave of Covid-19 which was in the quarter of April-June 2021. It was similarly in surplus during the first wave of Covid-19. In the quarter of June 2020, the current account surplus was a substantial 3.7 per cent of GDP and in the quarter of September 2020 it was 2.4 per cent of GDP. Lockdowns during these periods compressed domestic demand which reduced imports. Also, the initial phase of Covid-19 saw a fall in commodity prices. Depressed domestic demand and falling commodity prices combined to bring the current account into surplus. Then, as the economy recovered, imports increased and the deficits returned, like they did during the quarter of September 2021.
The recovery strengthened in the quarter of December 2021. It is therefore expected that the current account will fall deeper into deficit. We expect it to touch 2.2 per cent of GDP in the quarter. The current account deficit is expected to rise from USD 9.6 billion in the quarter of September 2021 to USD 17.6 billion in the December 2021 quarter.
Merchandise trade deficit, on payments basis, is expected to rise from USD 44.4 billion in the quarter ended September 2021 to a record USD 54 billion, or may be even higher in the quarter of October-December 2021. Preliminary foreign trade data based on movement of goods across customs borders show that the trade deficit had risen from USD 45.4 billion in the quarter ended September 2021 to USD 60 billion in the quarter ended December 2021. The payments data is expected to follow a similar pattern.
Nearly half of the merchandise trade deficit will be offset by the surplus India generates on trade in services. Surplus in trade in services is essentially the export earnings of India’s software industry. These rose smartly from USD 23.5 billion in the quarter ended March 2021 to USD 25.1 billion in the quarter of June 2021 and then to USD 26.8 billion in the September 2021 quarter. We expect this to rise further to USD 27.5 billion in the December 2021 quarter.
The current account deficit shrinks further with worker remittances that contribute USD 12-13 billion and local withdrawals or redemptions of NRI deposits. These, collectively classified under Secondary income remain flat at USD 19 billion per quarter. Nevertheless, they contribute to reducing the current account deficit.
The deficit is usually financed by foreign direct investments, portfolio investments and other investments. The December 2021 quarter, we believe, faced challenges on these fronts. Foreign direct investments declined to around USD 7 billion compared to USD 9.5 billion in the September quarter and USD 11.7 billion in the June 2021 quarter. Portfolio investments are expected to be in the red. These are expected to see an outflow of USD 6 billion.
The fall in portfolio investments reflects partly the expectation of an increase in interest rates in the US and even in Europe.
As a result, a significant portion of the current account deficit of the December 2021 quarter would be financed through a drawdown of reserves. An estimated USD 12 billion would have been needed for the purpose.
In spite of the sharp increase in the current account deficit during the quarter ended December 2021, the rupee didn’t weaken badly. The average exchange rate during the quarter at Rs.74.98 to a USD marks a 1.2 per cent depreciation compared to the Rs.74.09 exchange rate in the September 2021 quarter. The rupee had depreciated by 0.5 per cent and by another 1.1 per cent in the preceding two quarters. Part of this depreciation also reflects the strengthening of the USD. The Indian rupee did not similarly depreciate against the Pound sterling, the Euro or the Japanese Yen in the past two quarters.
India’s foreign exchange reserves are comfortable at USD 635 billion as they are the equivalent of 11 months of imports. The comfort in these reserves and in the expectation that commodity prices are expected to remain relatively weak in the coming quarter, it is likely that the rupee will continue to depreciate very gradually.We expect the current account to moderate in the March 2022 quarter. It is possible that it could moderate to less than 1.5 per cent, possibly closer to 1 per cent. The expectation for fiscal 2022-23 is a similarly benign current account deficit of about 1.2 per cent of GDP. The rupee is expected to remain reasonably stable with a very gradual depreciation as the world adjusts to interest rates rising in the West.