Drawdown in forex reserves despite record reduction in CAD

In an unusual development, apparently to reassure forex traders and analysts that all is well on external sector, RBI preponed the release of balance of payment statistics by almost a month to December 2. According to this data, the country’s current account deficit (CAD) narrowed sharply to $5.2 billion (1.2 per cent of GDP) in Q2, which is the lowest level over past 12 quarters or so. CAD was placed at $21.8 billion (4.9 per cent of GDP in Q1 & $21 billion (5.0 per cent of GDP) in Q2 of 2012-13. Lower CAD was primarily on account of a decline in the trade deficit as merchandise exports picked up and imports moderated, particularly gold imports.

On a BoP basis, merchandise exports increased by 11.9 per cent to $81.2 billion on the back of significant growth, especially in the exports of textile and textile products, leather and leather products, chemicals and petroleum products due to sharp gains in rupee terms. Side by side, merchandise imports recorded a decline of 4.8 per cent to $114.5 billion, primarily led by RBI’s restrictive measures-induced steep decline in gold import to $3.8 billion, from $16.4 billion in Q1 and $11.1 billion in Q2 a year ago. Net service income ($18.4 billion) recorded a y-o-y growth of 12.5 per cent due to computer services. Net outflow on account of primary income (profit, dividend and interest) amounted to $6.3 billion ($5.6 billion). Secondary income transfers ($16.1 billion) remained unchanged.

In a major change from the pattern noticed in quite a few recent quarters, capital flows too turned negative over the second quarter as a result of tumultuous conditions in forex market, which got mirrored in sharp depreciation of rupee during around mid-May-August period. This resulted in a record draw-down of forex reserves by $10.3 billion over the quarter, which is twice the size of CAD. Fickle portfolio investment and external loans by banks declined $13.2 billion. Driven by sharply better rupee returns NRI deposits were up $8.3 billion.

Trends in H1
The turnaround in export growth and decline in imports from July onwards led to a sharp improvement in the trade deficit to $83.8 billion in H1 of 2013-14 from $91.6 billion in H1 of 2012-13. Contraction in the trade deficit coupled with a rise in net invisibles resulted in a reduction of the CAD to $26.9 billion (3.1 per cent of GDP) from $37.9 billion (4.5 per cent of GDP) in H1 of 2012-13. Gold import has remained unchanged at $20 billion due to sharply reduced import in Q2 of the current fiscal. By the way, the reduction in gold import under official channels would have to be set off under smuggled gold, which as per estimates has increased noticeably in recent months. Both these routes have got the same impact on draft on country’s domestic currency equivalent. POL import increased from $80 billion to $83 billion; POL export fetched $32 billion ($27.5 billion). Services brought in a net $35 billion ($31 billion); the growth came essentially from computer services. Outflow in primary income increased by around $one billion to $11 billion, whereas workers’ remittances, a major source in current account to contain CAD declined, though marginally to $32.8 billion.

Net inflows under the capital and financial account (excluding change in foreign exchange reserves) declined to $15.1 billion, from $37.0 billion in H1 of 2012-13 owing to net outflow in portfolio investment in Q2. As a result, notwithstanding a lower CAD, there was a drawdown of foreign exchange reserve to the tune of $10.7 billion as against an accretion of $0.4 billion in H1 of 2012-13. The reduction in CAD, drawdown in forex reserves and lower capital flows were concentration mainly in Q2 of the ongoing fiscal.

The valuation loss, reflecting the appreciation of the US dollar against major currencies, amounted to $4.1 billion during April-September 2013 as against a marginal gain of $0.1 billion during the same period of the preceding year.