It’s not just that the current account deficit is widening—the means of financing it also became more risky in 2017-18. On the one hand, higher oil prices are raising the current account deficit and on the other, foreign direct investment—the most stable source of financing the deficit—has come down. This has led to greater reliance on foreign portfolio inflows, particularly volatile debt inflows and also on short-term credit.
This is a problem because the US Federal Reserve has been raising interest rates and has signalled more rate hikes to come. As RBI governor Urjit Patel wrote in an article in The Financial Times, the US Fed’s programme of shrinking its balance sheet, coupled with increased US Treasury issuance to fund a larger government deficit, has already led to dollar liquidity shrinking in international markets, particularly in the debt markets. This is behind the outflows from emerging market debt.
Indeed, economists expect India’s current account deficit to widen sharply in the current fiscal year. Suvodeep Rakshit, Madhavi Arora and Upasna Bhardwaj, writing in a Kotak Securities research report, say that even with an average price for Brent crude at $67.5 a barrel in FY19, an optimistic assumption given current levels, the current account deficit will be 2.6% of GDP, up from 1.9% in FY18. Assuming Brent at an average of $72.5, which too is lower than the current level, results in the current account deficit going up to 2.9% of GDP. And with Brent at $80 a barrel, the Kotak researchers say the current account deficit will be 3.3% of GDP.
The rapid deterioration in the trade environment as a result of protectionist policies is also likely to affect export growth, while rising investment demand will result in more imports. The United Nations Conference on Trade and Development, or UNCTAD, had in its recent World Investment report pointed to a slowdown in global foreign direct investment flows.
Gaurav Kapur, chief economist at Indusind Bank Ltd, says reliance on portfolio flows to finance this deficit will expose the country to the vagaries of fickle international capital flows, making funding difficult particularly during risk-off episodes. Kapur says the balance of payments surplus may disappear in FY19.
Within portfolio flows, the increased reliance on debt inflows carries more risks, as unlike equity, debt has to be repaid. NRI flows too have proved to be volatile, especially if the rupee depreciates. Earlier this month, credit rating agency Moody’s Indian affiliate, ICRA Ltd, said high global crude oil prices are likely to widen India’s current account deficit and pointed to slowing foreign portfolio investments as an area of concern.
The higher current account deficit will put downward pressure on the rupee and it may also raise the cost of Indian borrowing abroad. A note from Edelweiss Securities Ltd points out, “The stress on BoP is already visible in Q1FY19 with the INR depreciating 4%; the RBI had to intervene to stem the depreciation."