India’s current account deficit (CAD) rose considerably to $49 billion or 1.9% of the gross domestic product (GDP) in FY18 from the mild $14 billion or 0.6% of GDP in FY17.

In the current year, the looming US sanctions on Iran, and the balance of demand-supply inventories in various parts of the world, have led to a sharp spike in global crude oil prices. Given India’s dependence on imported fuel, its CAD is now expected to widen significantly to $76-80 billion or 2.9% of GDP in FY19. With this edging close to the threshold of 3% of GDP, which is considered to be a cause for concern, the size of India’s CAD has emerged as a key source of macroeconomic vulnerability.

Unlike 2013, when the sharp rise in India’s CAD was driven by gold imports, the predominant factor that is expected to widen the CAD in FY19 is the price of fuel, such as crude oil and coal. Consumer demand for electronic and electrical goods is also likely to push up India’s CAD, albeit to a smaller extent.

With India’s CAD expected to widen in FY19, the expected FII (foreign institutional investor) outflows are likely to result in a balance of payments deficit, even though FDI (foreign direct investment), external commercial borrowings and NRI (non-resident Indian) deposit inflows are expected to be healthy.

The rise in global crude oil prices, its knock-on impact on the size and financing of India’s CAD, and the weak global sentiment related to emerging market currencies, have resulted in the rupee recording fresh all-time lows.

The rupee has depreciated almost 14% relative to the dollar since the beginning of FY19, weaker than several peer Asian currencies.

To curtail the weakness in the currency, the government has announced several measures, which are intended to reduce the size of the CAD, and boost financial inflows, particularly debt flows, to finance the CAD.

For instance, import duties were raised on 19 identified non-essential items such as air conditioners, washing machines, refrigerators, speakers, footwear, radial car tyres, etc. The total value of these imports in FY18 was assessed by the government at 86,000 crore, or roughly $13-14 billion. This is equivalent to a low 3% of India’s total merchandise import bill for last year. In our view, the import duty increases are likely to have a modest impact of under $3 billion on reducing the size of the CAD in FY19.

Recently, public sector oil marketing companies (OMCs) were permitted to raise external commercial borrowings for working capital with a minimum average maturity of 3-5 years, from all recognized lenders under the automatic route, up to an overall ceiling of $10 billion. However, this is limited as compared to India’s estimated overall net oil import bill of over $100 billion for FY19.

Looking ahead, dollar strength, broader emerging market currency movement, the trend in crude oil prices, FII demand for Indian debt and equities, as well as the RBI’s actions, will drive the outlook for the INR. The rupee may well weaken to 75 to a dollar before retracing to an extent, especially if the recent dip in crude oil prices sustains, going forward.

Aditi Nayar is principal economist at Icra Ltd.