India’s current account deficit hits all-time high at 5.4% of GDP in Q2

India’s current account deficit (CAD) reached an all-time record of $22.4 billion in the quarter ended September 2012, even as capital account inflows rose sharply in reaction to government’s economic reforms, according to Reserve Bank of India numbers compiled by Crisil Research.

Current account refers to ‘permanent’ movement of money into the country, such as through export of goods, personal money transfers by Indians living outside India etc.. Capital inflows, on the other had, are in the more temporary, as they are in the nature of investments into the country and can be withdrawn by foreign investors when they feel like it.

India typically earns less money in the current account than it sends out, resulting in a net deficit or shortfall (known as current account deficit). A current account deficit leads to devaluation of the country’s currency (the rupee), higher prices inside the country etc., and possibly the country running out of money to pay for imports like oil.

However, India has been using capital inflows to tide over the current account deficit.

Crisil pointed out that the widening of India’s current account deficit in the September quarter was primarily caused by a dip in India’s exports of goods and merchandise. CAD was $18.9 billion in the September quarter of 2011. (See chart 1) As a percentage of GDP, the current account deficit rose to 5.4% from 4.2% a year earlier.

The $3.5 billion increase in the CAD was caused by a nearly $9 billion fall in India’s exports. Total goods exports were about $79 billion in the quarter.

Much of the impact of lower imports was cushioned by a $5.9 billion fall in imports (which negated the impact of lower exports). As a result, on account of goods trade alone, total deficit increased by $3.8 billion. In other words, there was a net positive impact due to non-goods trade items — such as worker remittances, personal money transfer, software and services exports and tourism earnings (also called services exports.)

Net services exports increased from $14 billion to $15.6 billion.

“Primary income witnessed a high net outflow of US$5.6 billion during the quarter, reflecting lower receipts from investment income and higher interest payments.

“Net personal transfers increased marginally by 2.8 per cent against a 12.6 per cent growth in Q2FY12. Within that, workers’ remittances growth was muted at around 7.5 per cent as against 17.7 per cent last year,” Crisil said.

The picture on the capital accounts side was very different. Encouraged by economic reforms, net capital inflows or surplus (investments) increased from $19.6 billion a year earlier to $23.9 billion during the quarter. This net surplus was exactly big enough to offset the $22.4 billion in the current account.

Both FII and FDI investments were higher. FII investments increased from US$ -2.0 billion in Q1FY13 to US$7.6 in Q2FY13.

FDI inflows were at US$8.9 billion, substantially higher than US$3.9 billion in the previous quarter and US$6.5 billion in Q2FY12.