Factors behind moderating CAD, how it will impact markets

The moderation in CAD, expected to be aided by the fall in commodity prices, rising workers remittances and services exports, and abatement of selling pressure by foreign investors, is set to boost sentiment on the investment front, as it will also bring the pressure off the currency.

What is the significance of CAD?

When the value of the goods and services that a country imports exceeds the value of the products it exports, it is called the current account deficit. CAD and the fiscal deficit together make up the twin deficits – the enemies of the stock market and investors. If the current account – the country’s trade and transactions with other countries – shows surplus, that indicates money is flowing into the country, boosting the foreign exchange reserves and the value of rupee against the dollar. These are factors that will have ramifications on the economy and the stock markets as well as on returns on investments by people.

According to the RBI, the CAD, which was at $36.4 billion for the quarter ending September 2022, is expected to moderate in the second half of 2022-23 and remain eminently manageable and within the parameters of viability. “CAD for the first half of 2022-23 stood at 3.3% of GDP. The situation has shown improvement in Q3:2022-23 as imports moderated in the wake of lower commodity prices, resulting in narrowing of the merchandise trade deficit,” RBI Governor Shaktikanta Das said while unveiling the monetary policy on February 8.

How did the trade deficit narrow in Jan?

January trade deficit narrowed to $17.7 billion, led by a sharp fall in imports, while exports fell by a smaller amount. “The sharp drop in imports was due to non-oil imports falling, mainly due to a price impact (softening in coal prices from mid-December), likely softening in domestic demand post the festive season (such as lower imports of transport equipment), and seasonal impact of the Chinese New Year holidays,” said a Kotak Economic Research report.

On the other hand, after the Rs26,000 crore sell-off by foreign portfolio investors in January, FPI outflows have come down to Rs4,400 crore in February so far. Workers’ remittances went up to $30 billion in the April-September 2022 period from $25.48 billion in the same period a year ago. At the same time, gold imports fell to $20 billion from $23.9 billion a year ago.

Will capital flows improve?

While there is a perception in the markets that capital flows could come under some pressure with China’s reopening and any deviations in monetary policy expectations, inflows are expected to increase to the economy on the whole, as foreign investors are unlikely to keep away from India, which is expected to witness one of the highest growth rates among large economies. At a time when the economies of many developed markets are expected to take a hit, the RBI has projected the GDP growth for the next fiscal (FY2024) at 6.4% and the Union Budget has indicated a capital expenditure of Rs 10 lakh crore (over $ 120 billion).

Moreover, with the rise in interest rates in India after the RBI hiked the repo rate by 250 basis points to 6.50%, non-resident Indian deposits, remittances, and FPI investment in debt are expected to rise further. NRI deposits had increased by $3.62 billion to $134.49 billion in the April-November period of 2022, according to RBI data.

Capital flow into India came under pressure in 2022 following the sharp rise in interest rates in the US. While FPIs pulled out Rs121,439 crore in 2022, even in the first six weeks of 2023, the FPI flow has been negative and the equity markets have witnessed a net outflow of Rs32,887 crore till February 16.

While the flow of capital will depend upon the interest rate movements and currency movements vis-a-vis the US dollar, there is optimism among global investors about India.

Earlier this week, Jonathan Gray, President and Chief Operating Officer of Blackstone, one of the largest global investors in India, said, “The fundamentals around growth are significant – young population, 100s of millions of people speaking English and India has more engineers than anywhere else in the world. India has a government now that is oriented towards growth and we believe that as more infrastructure comes into the country, it will continue to grow at a much faster rate than the rest of the world. We see tremendous opportunity in this country.”

How will moderating CAD impact the market?

While rising CAD raises concerns among investors as it hurts the currency and thereby the inflow of funds into the markets, a notable decline in CAD in January has improved market sentiments. The benchmark Sensex at BSE rose 407 points intraday on Thursday before closing at 61,319 with a gain of 44 points or 0.07%.

Experts say that CAD is very important for the currency. The value of an economy hinges a lot on the value of its currency and thereby, it also supports the equity markets by keeping the fund flow intact.

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While the numbers for January have come good, experts say this needs to be sustained. “The reduction in CAD, thanks to services exports, is a positive sign. However, we need to maintain this for many more months before we can say that the CAD worry is behind us,” said Nilesh Shah, MD, Kotak Mahindra Mutual Fund.