India’s CAD concerns make a comeback as crude climbs, trade gap worsens

The surge in global oil prices is showing up in trade numbers already as import bills begin to rise.

Worries over India’s current account deficit (CAD) have remerged, with crude oil prices surging to above $90 per barrel, and the merchandise trade gap widening to a 10-month high in August.

Being the world’s third largest consumer of crude oil, India is particularly vulnerable to any price fluctuations in this commodity. This is why, despite a consistent slowdown in exports, experts had, earlier in the year, dismissed concerns over the outlook for CAD citing softer commodity prices, particularly those of oil.

But India may be losing a key buffer for its external finances as a decision by Saudi Arabia and Russia to extend production cuts till the end of 2023 has propelled global crude oil prices higher in recent days. Brent crude prices hovered around $93.98 a barrel as on September 18.

Given the circumstances, some economists see a risk of rise in India’s current account deficit for 2023-24, with CARE Ratings expecting an increase of around 20 basis points from their earlier estimate of 1.6 percent of GDP, if the Indian crude basket averages $90 per barrel for the remainder of the year. This, in turn, could put more pressure on the rupee that had fallen to below 83.00 against the US dollar as recently as earlier this month.

The current account balance – whether in deficit or surplus – is a key indicator of the external health of an economy. India, being a net importer, is mostly expected to have a deficit, but an excessively large current account gap can be detrimental to an economy as it can lead to currency depreciation.

“Even if countries have fuel or energy subsidies in place, higher oil prices will result in a deterioration of the current account and fiscal balances (on-budget or off-budget), due to higher imported costs. We expect a 0.3 percentage points worsening in the current account balance for every 10 percent oil price rise,” according to a September 15 research report by Sonal Varma and Si Ying Toh, economists at Nomura.

Trade deficit

The surge in global oil prices is showing up in trade numbers already as import bills begin to rise. A sharp sequential uptick in goods imports led by rising inbound shipments of oil in value terms as well as volumes played a key role in India’s merchandise trade deficit increasing by almost 17 percent in August compared to the month before. This also qualifies concerns that New Delhi may find it tough to continue getting oil at discounted rates from Russia due to the global scenario.

“The merchandise trade deficit is likely to see upside risk from higher crude oil prices, especially if they sustain above $90 per barrel. Research has shown that the CAD/GDP ratio increases by 0.5 percentage points for every $10 per barrel increase in crude oil prices,” economists at Emkay Global, Madhavi Arora and Harshal Patel said in a note on September 17.

To be sure, in recent months, what was helping New Delhi contain its goods trade gap despite lacklustre demand for Indian goods was an equally significant fall in imports. But, in August, the sequential increase in inbound shipments was much higher at nearly 11 percent eclipsing a comparatively smaller rise of 6.9 percent in merchandise exports during the same period.

“This combination of domestic demand holding-up and weakness in external demand is likely to maintain-upward pressure on trade deficit,” said IDFC First Bank India Economist Gaura Sen Gupta, who sees an upside risks to her current account deficit estimate of 1.8 percent of GDP for 2023-24.

India’s current account deficit for 2022-23 amounted to 2 percent of gross domestic product (GDP), up from 1.2 percent in 2021-22. The sharp fall in CAD in the last quarter of 2022-23 from the record high number hit in July-September 2022 was attributed to two factors -- lower commodity prices, including those of crude oil, and a surge in services exports.

Silver lining?

Given that the outlook for global oil prices remains grim, India would like to bet on services exports mirroring last fiscal’s performance when it hit a record high. Although growth in services trade continues to hold its ground, it has lost some sheen compared to 2022-23. So far in 2023-24, services surplus averaged around $12.3 billion per month over April to August, lesser than $13.7 billion in the last quarter of the previous financial year.

This moderation was primarily driven by a slowdown in services exports that grew 6.9 percent so far in 2023-24 compared to 30 percent during the same period last fiscal. However, a decline in imports on the services side is so far helping to keep the overall number robust.

What could be considered as a silver lining is that though higher oil prices are almost certainly expected to widen India’s CAD, it is seen posing hardly any risks for domestic inflation. In a year packed with key state government polls followed by general elections in early 2024, the Centre is likely to keep a tight grip on local pump prices thereby shielding consumers from price increases.