Shrinking current account gap provides a reprieve for rupee

A shopper hands the Indian rupee banknotes to a roadside textile vendor in Mumbai. Photographer: Dhiraj Singh/Bloomberg

Economists are lowering their forecasts for India’s current-account shortfall, thanks to favorable trade trends that are proving to be a blessing for the rupee — currently among the worst performers in emerging Asia.

Barclays Plc expects the gap in current account — the broadest measure of trade in goods and services — to be 1.9% of gross domestic product in the year starting April 1, down from a 2.3% deficit it had estimated earlier. Citigroup Inc. slashed its forecast even further to 1.4% of GDP from 2.2% previously, reflecting a steady drop in goods imports and strength in services exports.

The lower prints will provide a tailwind to the rupee, which is vulnerable to a selloff, given the twin deficits in the nation’s budget and current account make it more reliant on foreign inflows. A narrowing shortfall will also take the pressure off the central bank to sell foreign exchange from its reserves to stabilize the currency and check imported inflation.

“We are encouraged by the fact that the narrowing of the trade deficit has sustained and services exports remain strong,” said Ashish Agrawal, head of foreign-exchange and emerging-market macro strategy research at Barclays in Singapore. “The lower current account deficit reduces dependence on financing flows and RBI’s dollar sales at the margin.”

That’s an added positive for the rupee, which along with Asian peers gained against the dollar after a dovish interest-rate hike by the Federal Reserve.

Services Surprise

What seems to have caught economists by surprise is the strong services exports print.

Services trade surplus was strong at $14.6 billion in February, building on January’s revised surplus of $13.8 billion. Services exports nearly touched $30 billion in both January and February, an increase of about 40% on-year.

HSBC Holdings Plc attributes a part of this rise to Global Capability Centres set up by large multinational corporations. India is home to about 40% of global GCCs, and this ratio is only expanding as they rise in scope, an HSBC report said.

“Services trade surplus is truly a hero in India’s foreign trade story right now,” said Dhiraj Nim, an economist and forex strategist at Australia and New Zealand Banking Group, who is confident the trend will continue.

Barclays expects the improving external sector fundamentals and relatively cheap valuations to help the rupee rally later as the dollar weakens. But most remain cautious amid global volatility and the Reserve Bank of India’s aim to build back reserves at every opportunity.

From the current account perspective, this augurs well for the rupee, said Madhavi Arora, lead economist at Emkay Global Financial Services Ltd. That said, the global situation is extremely fluid and could adversely impact global risk appetite for risk EM assets, including the rupee — emerging Asia’s worst performing currency last year and among the bottom this year.

“Thus the capital account side also needs a watch,” she said.