India’s current account deficit narrows further in February, low commodity prices influence both sides of trade

India’s current account deficit for February narrowed to USD 6.5 billion from January’s USD 7.6 billion, with base effects restricting the extent of decline in export growth to -5.7% y/y. Meanwhile, imports declined 5%. Both sides of the trade was influenced by low commodity prices, as oil imports dropped 22% y/y, taking the year-to-date decline to 40.5%. Non-oil imports strengthened with the help of 29% decline in gold purchases, with investment-related imports showing moderate signs of stabilization.

On the exports end, petroleum exports fell, but the decline in non-oil shipments eased due to a pick-up in jewellery and gems, electronic goods and pharma, amongst others. Rebound in trade balance is positive for external balances. Current account deficit in 2016 is expected to narrow to -0.6% of GDP, the third continuous year of below -2% reading.

This eases the reliance on portfolio flows to finance the current account gulf, just as the non0debt creating investment flows share increase. Meanwhile, apart from the narrowing of current account deficit, soft readings of CPI/WPI readings released recently reinforced the likelihood that the central bank will lower rate by 25bp.

While an inter-meeting move was expected just after the Budget, it seems even more possible that the RBI might prefer to be less reactionary and instead wait till the scheduled policy review that will take place in early April. After the expected rate cut in early April, the central bank is likely to pause on the rate cycle as the effect of higher pension and salaries, along with tentative stabilization in oil prices require attention.

The weaker rupee has also led to defacto easing. Even if low inflation suggests a low interest rate environment, the RBI will be cautious regarding the implications on savings, with the official leaning for real rates to be kept between 1.5-2%. As inflation is likely to reach the firmer end of 5-5.5% in 2017, there is limited room to aggressively cut interest rates. Even though financial markets are expected to cheer the rate cut, the effect on the real economy depends on the efficiency of the transmission process.