India’s current account deficit, now at a decadal high of 3%, may reduce this year

India’s current account deficit seems to have widened to 3 percent of gross domestic product last year, the biggest external shortfall since 2012 when the country was on the brink of a balance of payments crisis. It may, however, narrow down a bit in 2023 as commodity prices ease and domestic demand comes off the boil, according to Capital Economics.

“While this still leaves the rupee vulnerable, we think the bulk of the depreciation against the US dollar has now passed and the currency will end 2023 stronger than its current level,” Shilan Shah, Senior India Economist, said in a note to investors.

India’s current account deficit has ballooned over the last year amid the surge in commodity prices following the outbreak of the war in Ukraine. There are concerns that the gap may remain wide given that exports are slowing amid recession in the West.

Official data released last week showed India’s current account deficit widened to $36.4 billion or 4.4 of GDP in the third quarter of 2022 from $18.2 billion or 2.2 percent of GDP in the second quarter.

The deterioration in the current account deficit was driven by a widening in the goods trade deficit due to a fall in exports, the economist said.

The rise in the current transfers surplus as a result of increased inward remittances from the Gulf, helped by higher oil prices, only partially offset the larger goods trade deficit, he added.

While exports are likely to drop further as the global economy heads into recession this year, imports to also weaken as commodity prices ease back in the next few months and as domestic demand softens, the research house said. “All said, our forecast is for the current account deficit to narrow to around 2 percent of GDP in 2023,” it added.

The rupee, which depreciated by almost 10 percent against the US dollar in 2022, stands to benefit from the improving external balance. The currency would probably have weakened more were it not for large-scale FX intervention from the central bank, the economist said.

While India’s foreign exchange reserves are around $80 billion below their peak, it is not a cause for concern as the buffer of reserves is significantly larger than most measures of adequacy suggest is needed.

“We expect the RBI to continue to intervene in the FX market to defend the rupee if it comes under further downward pressure in the near term,” Shilan Shah said. “Having said that, our view is that the bulk of the depreciation has now passed and rupee will strengthen over the course of this year due to the improvement in the terms of trade and as US Treasury yields fall back.”