The one bright spot in India’s economy

With the decline in crude oil prices because of a standoff between Russia and the members of the Organization of the Petroleum Exporting Countries led by Saudi Arabia over production cuts, and a weakening global demand for oil and gas, oil importers like India will witness major gains. Not just because it will see a substantial reduction in its oil annual import bill, but also result in the country’s current account balance turning surplus after 17 years.

According to an economic research note by Sajjid Z. Chenoy, chief India economist at JP Morgan Chase, titled INR: How 2020 is different from 2013, the country’s current account is expected to turn surplus in FY21 for the first time since FY04. And his calculation shows that the “surplus will be around $20 billion or 0.7% of the country’s GDP in FY21 versus a current account deficit of 1% in FY20.” In other words, India is exporting more capital to the world than importing it so less external debt.

His current account surplus projection is based on certain assumptions. It expects oil prices to range between $29 and $35 per barrel for a year, which will have a “strong bearing on India’s current account dynamics.” After all, for every $10 per barrel fall in prices, India's current account balance improves by 0.4% to 0.5% of the GDP. Moreover, slowing domestic growth and a weak import growth—other constituents of the current account balance—will offset the weak export growth expected in FY21.

So, what does a surplus current account mean for the economy is such distressing times? Having a current account surplus and a substantial war chest of foreign exchange reserves with the Reserve Bank of India (as on February 14, the central bank had forex reserves of $476 billion) means that India has a “meaningful buffer’’ to deal with potential capital outflows from the economy. Hence, a sudden flight of foreign capital from the Indian shores—like in March—will not destabilise the economy. For countries running a large current account deficit, any sudden outflow can result in strong depreciation of the currency and result in debt defaults.

In March the Indian capital market witnessed the largest-ever outflow of foreign portfolio, $14 billion, which was nearly double of what the country had seen during the Taper Tantrum of June 2013. Foreign portfolio managers pulled out nearly $7.2 billion that month from India, as soon as the U.S. Fed announced that it would reduce the pace of buying U.S. government’s treasury bonds, thereby lessening liquidity in the economy. “Even after normalising across time March 2020 was the largest monthly outflow on record,” says Chenoy.

Despite large outflows, the Indian rupee has outperformed the currencies of other emerging markets partly because of the improvements in the external sector fundamentals. India’s gross and external liabilities are just 39.7% and 15.7%, which are relatively modest compared to other countries in the region, says the report.

Having a war chest not only means that the RBI can afford to sell dollars to companies when they need especially in times when they are facing a liquidity crunch, but also protect the rupee from further devaluation vis-à-vis the dollar by aggressively intervening in the market. The good news is that India’s external debt to GDP is only around 19.4%, which is far better than those of many other emerging economies like Turkey and Russia.

Secondly, having a surplus current account and substantial reserves means that the country has enough firepower to ensure that companies do not default on their foreign borrowings. After all, the past few years have seen Indian corporates borrowing heavily from the international markets because of the credit crunch in the domestic market, especially after the IL&FS crisis of September 2018. India Inc. has been further helped by the benign interest rate and more than adequate liquidity in the global markets.

Thirdly, a surplus current account implies that the fundamentals of the Indian currency have improved over the years, despite temporary upheavals in the real economy and the weakening of global growth. The rupee is currently trading at around Rs75.91 a dollar, a historic low. However, in the medium term what will determine the quantum of capital flows, asset prices and the strength of the Indian currency will depend to a large extent on the growth differentials between India and the rest of the world. Hence, growth matters.