Keeping FDI/FII engaged is critical for surplus BoP
Call it luck if you will, but the Modi government couldn’t have had a better start with, on the day it was sworn in, the current account deficit (CAD) for Q4FY14 falling to a low of $1.2 billion or a mere 0.3% of GDP. The collapse of the CAD, of course, is a continuing story over several quarters—it was 4.9% of GDP in the first quarter of FY14—coinciding with the fall in gold imports. For all of FY14, the CAD coming in at a 5-year low of $32.4 billion or 1.7% of GDP was primarily the result of a 7-8% contraction in imports while exports grew at under 4%—nearly 70% of this import contraction, in turn, was due to lower gold imports. It also helped that services exports grew over 10% in FY14.
The imports picture, obviously, will change once the economy picks up—coal imports of $16.4 billion in FY14 will certainly rise once GDP does—and as import curbs on gold are lifted. But, as this newspaper has pointed out before, the jump in gold imports will not be as sharp as imagined since, contrary to what the government believed, gold imports did not fall due to the import restrictions, they fell when global gold prices crashed to $1,330 per ounce in 2014, from an average of $1,669 per ounce in 2013. As a result, gold imports into India collapsed by over a third and the import bill fell from around $54 billion in FY13 to $29 billion in FY14. Given that global price forecasts for FY15 are even lower, chances of a sharp pick up in gold demand are low. Based on this, most analysts are pencilling in a marginal worsening of the CAD. While Crisil is looking at FY14’s 1.7% of GDP CAD growing to 2.2% in FY15, several others such as Citi and Nomura are looking at a number around 2% or even lower.
Though that deficit looks easily financeable, it is best not to be complacent. A look at how the CAD was financed over the last couple of years is instructive. FY14’s $32.4 billion CAD was financed by a $48.8 billion inflow on the capital account, leaving the country with a balance of payments (BoP) surplus of $15.5 billion. Kotak Institutional Equity’s assumption is that, if all goes to plan, FY15 will have a BoP surplus of between $25.8 billion and $31.5 billion. This involves, for instance, net FDI levels climbing from $21.6 billion in FY14 to $25 billion in FY15 and FII from a mere $4.8 billion in FY14—this would have been minus $10 billion had the post-Modi surge not occurred since September 2013 —to a whopping $20 billion in FY15. Right now, the FII inflows look possible, but were the Modi government to falter, this can’t be counted upon. Also keep in mind that, of the $48.8 billion of capital flows in FY14, $38.9 billion came from NRI deposits—that is $25billion over FY13 levels, and came in only because of the attractive RBI scheme, and can’t be repeated. Comfortable as the FY15 CAD looks, it still needs to be financed.