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May 08, 2017

External account and possible risks

Despite risks, CAD in safe zone


India's key macroeconomic indicators have been in the pink of health in the past three years. Of these, the current account deficit (CAD), a key measure of external vulnerability, stands out. A sharp decline in CAD in fiscal 2014,and its downward trajectory since then has been largely shaped by an equally sharp correction in commodityprices.


We expect CAD to rise to 1.3% of GDP in fiscal 2018 from an estimated 0.9% in the preceding fiscal.Two factors that will put upward pressure on CAD are:

  • The period of fall in commodity prices, which was instrumental in tamping down CAD, has now come to anend. Commodities prices have started firming up and expected to rise further in fiscal 2018. Thecommodity price movements have an asymmetric effect on CAD - when commodity prices fall the tradebalances shrinks as we import more commodity linked stuff then we export and vice versa whencommodity prices rise.
  • Rising protectionist sentiment does not augur well for goods and services exports. While global demandhas started recovering, the popular mood in advanced economies is turning against international trade. Ifthese sentiments get reflected in policy action, it will create barriers for exports.

While the effect of commodity prices plays out rather quickly, that of protectionism could take longer to play out.Another happy tiding on the external front was that while the quantum of CAD was trending down, the foreigncapital flows needed to finance it were becoming more durable. There was a clear shift towards foreign directinvestment (FDI) flows. While FDI flows still remain healthy, off late there has been a surge in portfolio flows whichare generally volatile in nature.


While there is some adverse movement in CAD and its financing, it is not a cause of concern at-least in this fiscal.May saw some big-bang data releases. With the Wholesale Price Index (WPI) and Index of Industrial Production(IIP) now measured with fiscal 2012 base year, finally all the key macroeconomic data has moved to one commonbase year. This will greatly facilitate the comparability of data.


The new data series shows the growth-inflation mix is better than estimated earlier, with inflation down andindustrial output up. IIP growth averages 3.8% for the past five fiscals now compared with 1.4% as per theprevious data series. The booster comes from manufacturing, which has more than three-fourth weight in IIP.That’s par for course because fast-growing contemporary sectors have been included and laggardly, obsoletesegments removed. The change in the basket of commodities and weights have reduced average WPI inflation bya percentage point to 2.3% for the past five fiscals.


The Consumer Price Index (CPI) inflation again surprised, rather pleasantly. CPI inflation in April slipped to 3% -the lowest for the period for which this series is available. A record growth in production of pulses in fiscal 2017and a high base effect in case of vegetables was behind the deflationary trend in these commodities. The baseeffect driven party will continue for 3-4 month before CPI inflation starts rising again. So the current dip may notbe a reason for the RBI to cut interest rates.