Finally a silverlining: CAD to fall to 3.5% in FY13: Citi

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Amidst the flurry of gloomy macroeconomic predictions after the dismal nine-year low growth numbers last fiscal, there is some silver-lining as lower current account deficit (CAD), which according to a Citi estimate, is set to fall below 3.5 per cent of GDP in fiscal 2013.

"While most macro variables (growth, fiscal, inflation) still need to bottom out, the sharp fall in oil prices and lower gold demand are likely to stem weakness in the CAD. We now expect the FY13 CAD to improve, albeit marginally to USD 65.3 billion or 3.5 per cent of GDP against an initial projection of USD 74.3 billion or 4 per cent of GDP in FY13," says Citi India chief economist Rohini Malkani in a research report.

The CAD is the difference between a country's exports and imports. Due to the high dependency on imported oil, the country has traditionally been facing trade deficit, where the import expenses have always been higher than export earnings.

In FY12, it is feared that the CAD will cross the 4 per cent mark, as till December it was hovering around 4 per cent of GDP, which grew by a poor 6.5 per cent, a nine-year low.

The worry arises from the sharp deceleration in exports in Q4 of FY12 and not a commensurate decline in imports. It can be noted that in FY11, the CAD stood at a comfortable 2.7 per cent of GDP, which grew 8.4 per cent.

While exports crossed the target by a small margin at USD 303.8 billion (against USD 300 billion target) so were imports, which touched USD 489 billion in FY12. Out of this, the oil bill stood at a whopping USD 155.6 billion, while gold and silver imports touched USD 61.5 billion.

The country meets over 70 per cent of its oil needs by imports. This projected improvement in the CAD is primarily because of the fall in oil prices and lower imports of gold, says the Citi report, which also projects a 20 per cent decline in gold demand.

Another reason for the optimism is the lower export growth given the worsening global environment, which is likely to clip only at 10 per cent against an earlier projection 17 per cent, says Malkani.

Stating that the country will save USD 18 billion in oil imports due to the falling prices (from USD 127 a barrel in February to USD 96-98 a barrel as of last week, making this one of the worst weekly fall in over a decade), the report says oil comprises 30 per cent of the import bill.

Citi pegs its oil estimates at USD 100 a barrel this year which is down from an average of USD115 in 2012.

Taking into account petro-product exports, every USD1 a barrel change in oil price impacts the CAD by USD 900 million, says the report.

On the projected 20 percent fall in gold demand on the back of rising prices and the recently imposed tax, the report says, this lower demand will see the country savings of USD7 billion.

Gold import comprises 10 percent of total imports and last fiscal, it crossed USD 61.5 billion. Over the last few years, gold imports have risen from 600-700 tonne to 800-900 tonne.

However, Malkani warns that despite this, the overall BoP (balance of payment) position is still likely to be in the red due to poor FDI inflows.

Compounding the problem is the weak rupee, which according to her, is likely to remain at 54-56 levels in the near-term.

"We expect the overall draw-down to the reserves to be limited to USD 4.6 billion against USD 8.3 billion expected earlier in the current fiscal. Further consolidation to the CAD could result in a return to forex accretion in FY14 to around USD 2.2 billion," Malkani says.

Of the four deficits contributing to the de-rating of the India story, say the Citi report, the sharp deterioration in CAD from USD 45.9 billion (2.7 per cent of GDP) in FY11 to USD74.3 billion (4 percent of GDP) in FY12 (estimate) is the massive 21 per cent fall in the rupee.

Despite the changing composition/direction of exports and recent weakness of the rupee, the near-synchronised global slowdown including in China, Brazil and other Ems and worries about the US fiscal cliff are likely to take a toll on the country's exports, says the report, adding however, the positives are likely to offset weaker exports, thereby resulting in an improvement in the CAD.

However, the report warns that capital flows will remain lacklustre during the year. While trends on the current account are improving, the picture on the capital account is not as bright primarily due to lower FDI inflows largely driven by non-conducive domestic policy environment; commercial borrowings moderating due to deleveraging.