Trinh D. Nguyen (Natixis) | India’s nominal GDP rose to $3.5 trillion by 2022, raising its global share by one percentage point to 3.5% and GDP per capita by 64% to 2,500 in the past decade. But diverging from its past, the current account deficit (CAD) narrowed from -3.5% of GDP to -1%, on average. The Indian economy grew more than expected, pushed by higher government infrastructure spending and household consumption. A narrower CAD has made India much more resilient to external shocks. While positive, it also reflects Indian corporates’ deleveraging and weakened investment but with a clear silver lining, namely the more efficient capital allocation. In this report, we analyze the drivers of India’s improved current account balance and assess where it is headed as investment broadens.
The current account (CA) balance is an income statement of net trade (merchandise and services) and net corporate and household international flows (repatriation of profits and remittances for the latter). During the five-year period leading up to the Fed’s tapering tantrum in 2013, the average CAD was -3.5%. That narrowed to -1.4% of GDP during 2014 to 2018 and then further to -0.8% from 2019 to 2023. By details, the key driver is the declining of goods deficit; service export surplus also accelerated while remittance income got slightly smaller. Within goods, the India-manufactured deficit fell, especially machinery thanks to more exports and fewer imports, fuels and gold deficit declined and the metals deficit is only up only marginally. The goods deficit is less driven by oil prices than in the last decade thanks to more investment in renewable than diversified energy sources and more refined oil exports. In services, the transport deficit narrowed while business services surplus widened, with IT export remaining most key.
The improvement of the CAD reflects greater efficiency of India’s investment. While government capital expenditure rose, banks, corporate and government balance sheets got leaner. Non-performing loans declined, and corporates deleveraged. On the government side, debt is higher, but spending is more geared towards productivity enhancing projects such as highways and energy investment than petroleum subsidies. We calculated the incremental capital to output ratio (ICOR) and India is indeed more efficient in its capital allocation as the ICOR declined since 2020. The RBI has accumulated foreign exchange reserves to cover 11 months of imports thanks to capital inflows and much narrower CAD.
As investment broadens from the public to the private sector, machinery and metals imports will likely increase. Should India continue to attract manufacturing FDI and build domestic capacity, its merchandise deficit should be contained. On the service side, we expect IT and business export surplus to widen further but the travel deficit to worsen. We expect the transportation service deficit to narrow to offset outbound tourism as India income rises and demand for travel increases. In other words, as investment rises, India needs to continue to make progress on both goods and service exports to continue to narrow the current account deficits.
Lower current account deficit shields India from external shocks and future success hinges on sustaining it
