Worries around Crude Oil prices balancing out!

Rising crude oil prices have been in the headlines over the past few weeks. A host of factors such as supply cuts and low inventories have pushed up crude oil prices. Traditionally, volatility in crude oil prices has been the bane of India’s current account deficit position. For example, spike in crude oil prices post the Russia Ukraine War led to an increase in the merchandise trade deficit. Over time, India has been able to build a significant buffer in the form of Services exports, led by software service exports, which have been a key support with steady cashflows. Further, improved flows outlook in Indian debt markets from inclusion in an Emerging Bond Index also bodes well for the Balance of Payments position in the next year.

Chart 1: Rise in crude prices generally a concern for goods trade deficit

Chart 2: Increase in Services exports offsets higher goods deficit

Source: Bloomberg, CMIE

What does the latest data on Balance of Payments say?

• Current account deficit lower than last year, but wider than previous quarter

  For the quarter ended June 2023, India’s Current Account Deficit was reported at US$ 9.2 billion (1.1 per cent of GDP), which was higher than US$ 1.3 billion (0.2 per cent of GDP) in the preceding quarter, but lower than US$ 17.9 billion (2.1 per cent of GDP) in the quarter ended June 2022. The widening of CAD on a quarter-on-quarter basis was primarily on account of a higher merchandise trade deficit coupled with a lower surplus in net services and decline in private transfer receipts.

• Current account deficit supported by portfolio flows and FDI

  India saw strong portfolio inflows by FPIs (Foreign Portfolio Investors) in equities during the quarter, of about US$13bn, along with US$2bn in Debt. While FDI Flows were positive, Net FDI inflows reported a drop on account of slower inflows over the quarter coupled with higher investments by Indian companies abroad.

What are some of the key factors going forward?

• Improving share of India’s net exports to support external account

  Concerted efforts at improving India’s share in global trade, especially on the exports side, has helped in increasing India’s share in World trade to go from 0.7% in 2000 to 1.9% in 2022. The Services share has seen a much faster increase, from 1% in 2000 to 4.4% in 2022. Various initiatives to boost manufacturing (Make in India, PLI etc.) along with numerous bilateral and multilateral trade-agreements could give a fillip to India’s goods exports in future. The picture on India’s trade was covered in detail in the recent edition of our Chartscope, titled “Trade Talks – A bird’s eye view of India’s goods trade”.

• Bond inflows and other capital account inflows to aid current account volatility

  Historically, bond inflows by foreign portfolio investors have not been significant, and the overall external debt as a % of GDP is low at 18.6% of GDP, from 23.1% of GDP as of March 2016. Recent announcement of EM Bond Index inclusion by JP Morgan is a shot in the arm, as it could lead to foreign inflows of US$25bn into Indian sovereign bonds over Jun’24-Mar’25 according to analyst estimates. These bode well for India’s Balance of Payments in FY2025.

• Efforts at substitution of crude oil in Indian energy mix

  The government has a five-pronged strategy to reduce import dependence. It comprises promoting biofuels and other alternate fuels/renewables, promoting energy efficiency & conservation measures, giving thrust on demand substitution, increasing domestic production of oil and gas and refinery process improvements.

Conclusion

While crude prices have softened in the past few days, from US$95/bbl to US$90/bbl, they continue to stay at elevated levels and pressure may continue. At the current juncture, increasing strength of the US Dollar relative to other currencies may continue to increase, and put some depreciating pressure on the Indian Rupee against the dollar. On the flipside, India’s improving share in world exports of goods and services are acting as an effective counter, while dependencies on crude are being attempted to be mitigated in the medium term. On balance, while there are risks to capital flows in the near term, the India’s BOP position seems comfortably placed with improving current account outlook and stable macroeconomic factors.

Glossary of key terms discussed

Sources: Centre for Monitoring Indian Economy (CMIE), Reserve Bank of India, and other publicly available information

About Tuesday’s Talking Points (TTP): TTP is an effort by HDFC AMC to guide key conversations in the Indian financial markets and investing ecosystem. We aspire to do this by providing relevant facts, along with our perspective on the issue at hand. If you have a topic that you would like to be featured here please write to us at [email protected]

Disclaimer: Views expressed herein, involve known and unknown risks and uncertainties that could cause actual results, performance, or events to differ materially from those expressed or implied herein. Stocks/Sectors/Views referred are illustrative and should not be construed as an investment advice or a research report or a recommendation by HDFC Mutual Fund (“the Fund”) / HDFC Asset Management Company Limited (HDFC AMC) to buy or sell the stock or any other security. The Fund/ HDFC AMC is not indicating or guaranteeing returns on any investments. Readers should seek professional advice before taking any investment related decisions.

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.