Is India’s current account surplus a reason to rejoice?

Coming after 17 years, is a current account surplus an indicator that all is well with the Indian economy?
Express Illustrations by Amit Bandre
Express Illustrations by Amit Bandre

The news of a current account surplus of 0.9% of GDP ($24 billion) in Fiscal Year 2020-2021 comes amid concerns regarding other macro-economic parameters—the GDP, employment and inflation. Coming after 17 years, is such a surplus an indicator that all is well with the Indian economy and that we have finally turned the corner? Or is it that the surplus on our current account bodes even worse than having a current account deficit (CAD), especially during these pandemic times? The truth may be closer to the second explanation, with the surplus indicative of deeper problems.

The current account balance is based on India’s receipts from and payments to the rest of the world for four items: goods, services, primary income and secondary income. Based on the balance of these four items, the current account could either show a surplus or a deficit.

The chief contributor to a CAD is normally the trade deficit. With India being a large importer of gold, oil and capital goods, India’s imports of goods outstrip its exports to the rest of the world, leading generally to a negative trade balance. In 2020-2021, however, India’s trade deficit shrank by 35% compared to the previous year [from (-)$157.5 billion to (-)$102.2 billion]. The shrinking trade deficit contributed in large measure to the current account balance turning to positive. Understanding such shrinkage in trade deficit, thus, is key to understanding India’s recent current account surplus.
India’s trade deficit shrank since imports compressed to a far greater extent than exports. Thus, while exports shrank by 7.5%, imports went down by a whopping 16.6%. The decline in exports was not unexpected, with the pandemic-led recession and restrictions in the rest of the world. It is the sharp decline in Indian imports and the components of such shrinkage that are worrisome and are related to India’s steep reduction in the GDP and the associated demand.

There was a sharp decline in the petroleum, oil and lubricants (POL) imports by 58%, from $130.6 billion in 2019-20 to $82.6 billion in 2020-21. While crude prices were extremely volatile and the average annual price of India’s crude oil basket (COB) for April 2020-February 2021, at $42.72 per barrel, was 30% lower than what it was in 2019-20 (and the lowest since 2004-05), the decline has been on account of quantum of imports as well. Such a steep decline in POL and capital goods imports can be traced to the slump in demand and industrial production, especially following the pandemic. Thus, the reduction in trade deficit should not be confused with an improvement in India’s competitiveness or even the nation moving on to the path of self-reliance.

As regards the second item, India’s service exports did well and contributed to a surplus of $88.6 billion, despite the slump in travel services. While India suffered a negative impact of (-)$3.0 billion on account of travel, it seems business and education-related travel out of the country continued far more than that of corresponding foreign travel here. The impact of business and education-related travel thus was negative. This was partly made up for through a positive impact of personal and health-related travel of foreigners to India.

India’s software service exports continued to provide a safety net to the current account, contributing $89.7 billion of surplus. Meanwhile, home-bound Indians provided the growth drivers for streaming platforms such as Amazon Prime, Netflix and Disney-Hotstar. India thus consumed a whole lot more of cultural content through imports than what it exported, with personal cultural and recreational services recording (-)$0.474 billion.

India’s primary income within its current account was influenced largely by its status as a preferred destination for foreign investments, both foreign direct investments (FDI) and foreign portfolio investments (FPI). A large positive inflow of such investments on the financial account, paradoxically, results in an equally large negative impact on the current account. Thus, India paid for its $44 billion worth of FDI inflows and $36.1 billion of portfolio receipts in the form of a large payout of $41.3 billion by way of overseas investment income.

Interestingly, however, the outflows on account of FDI and FPI were not spread across equally, with outflows of income on account of interest and equity far greater for direct investments than portfolio investments. Thus, the $44 billion worth of foreign direct investment resulted in an outflow of $27.4 billion investment income, compared to the $6.8 billion worth of outflows on account of the $36.1 billion worth of portfolio investments. It appears then that while the FDI is supposed to be a better source of financial flows due to its long-term nature and its employment generation effects, its negative impact on the current account for India has been far greater than that of portfolio flows. While remittances—the chief component of secondary income—continued to be positive and contributed a $73.6 billion surplus to the current account, there was a decline in this item compared to 2019-20.
Thus, the surplus on the current account of the type seen is neither permanent nor desirable. It does not give a reason to rejoice. India must look at the contributors to individual items within the current account to see the implications of a surplus/deficit in each and work at making our current account balance genuinely stronger.
(Views are personal)

Tulsi Jayakumar
Professor, Economics and Chairperson, Family Managed Business at Bhavans SPJIMR

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