Chennai, NFAPost: A rise in global uncertainty or geopolitical tensions often leads to capital seeking flight to safety, thereby foreign portfolio investments leaving the shores of emerging markets. COVID-19 also triggered this behaviour, and India witnessed a foreign portfolio investment outflow of $16.05 billion in March 2020 and $1.97 billion during April-May 2020.

However, unlike the episode of taper tantrum of 2013, the impact of foreign investors pulling their money out of India did not lead to any macroeconomic instability. Interestingly, foreign exchange reserves increased to $517.64 billion (foreign currency assets: $477.81 billion) on July 17, 2020 from $476.88 billion ($442.21 billion) at end-March 2020, says India Ratings and Research.

It is this swelling of foreign exchange reserves that in combination with benign oil prices and tepid imports, leading to a current account surplus, has helped the Indian rupee to remain broadly stable since mid-March 2020, despite deterioration in some of the other macro parameters such as retail inflation, fiscal deficits and negative GDP growth. Ind-Ra estimates the average value of rupee to be INR75.98/USD in FY21 (FY20: INR70.88/USD).

India is a net commodity importer especially due to a high oil import bill. As a result, the country’s trade account is in perpetual deficit. However, a sustained surplus in services account coupled with remittances, together known as invisibles, provides adequate support to the trade deficit. 

As the FY21 growth outlook is bleak and Ind-Ra expects the economy to contract 5.3% yoy in FY21, both exports and imports could decline for the second consecutive year in FY21. Therefore Ind-Ra expects trade deficit to decline to a 13-year low to $101 billion in FY21 (FY20: $157.5 billion).

Surplus in services trade averaged $76.489 billion during FY16-FY20. Due to the COVID-19 pandemic, the revenue growth expectations of leading Indian software companies are flat to low single digit for FY21. Ind-Ra expects trade in services to decline 14% yoy in FY21 $73.0 billion (FY20: $84.9 billion). Transfers or remittances is another big component of invisibles and averaged $65.24 billion during FY16-FY20. 

Ind-Ra expects net transfers to decline 25% yoy in FY21 to $57.2 billion. According to the World Bank, remittance flows in 2020 are projected to decline across all regions in the world.

India witnessed a surplus on current account in 4QFY20 ($558 million, 0.1% of GDP) after a gap of 51 quarters. The last time India had witnessed a current account surplus was in 4QFY07 ($4,223 million). Ind-Ra expects a current account surplus even in 1QFY21, as trade deficit declined to $9.12 billion and surplus in services trade during April-May 2020 was $13.98 billion. However, Ind-Ra estimates the current account to be in deficit of 0.1% of GDP ($3.3 billion) in FY21, which will be the lowest current account deficit in the last 16 years.

Capital account of India has remained in surplus for most of FY01-FY20; there have been only three instances (FY09, FY12 and FY19) when inflows in capital account fell short of covering the current account deficit. Net foreign direct investments have been a major and the most stable source of inflows in the capital account. It averaged $35.13 billion as against net average portfolio inflows of $5.23 billion during FY16-FY20. 

Loans (external assistance, government borrowings and short-term credit) are estimated to increase to $25.9 billion in FY21. Ind-Ra expects the capital account inflows to increase to $67.3 billion in FY21 (FY20: $83.2 billion), leading to $64 billion increase in foreign exchange reserves.

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