India's Current Account Deficit Projected To Widen In FY23, Then Stabilise, Says IMF

India's external position is broadly in line with its medium-term fundamentals, according to the International Monetary Fund.

While the current account deficit is forecasted to widen in the ongoing fiscal, it will stabilise over the medium term, the IMF said in its External Sector Report for 2022.

Current account deficit is forecasted to widen to 3.1% of the GDP in FY23 from 1.2% in FY22, according to the IMF.

However, it is broadly consistent with India’s level of per capita income, favourable growth prospects, demographic trends, and development needs, the report said.

In part reflecting the impact of the Russia-Ukraine crisis on oil prices, the current account deficit is projected to widen in FY23 but then stabilise over the medium term, according to the report.

The authorities have made some progress in external trade promotion and the liberalisation of FDI and portfolio flows, but the existing tariff structure remains broadly unchanged, it said.

While the current account balances are projected to increase for commodity exporters, such as Saudi Arabia and Indonesia, the impact is the opposite for commodity importers, such as India, whose current account deficit is forecasted to increase by 1.9 percentage points of GDP, the report said.

Noting that trade restrictions also remain high in India, the report outlined potential policy responses that included gradual withdrawal of fiscal and monetary policy stimulus, development of export infrastructure, and negotiation of free trade agreements with the main trading partners to provide a sustainable boost to exports. It can be accompanied by further investment regime liberalisation and a reduction in tariffs, especially on intermediate goods.

Structural reforms could deepen integration in global value chains and attract foreign direct investment, thus, mitigating external vulnerabilities, the report said.

According to the report, volatile portfolio investments are very sensitive to changes in global financial conditions and country risk premia.

While FDI inflows covered the current account deficit in FY22, structural reforms and improvement of the investment regime to promote FDI are needed, the IMF report said.

Expected inclusion of India in international bond indices should increase portfolio investment inflows for financing the current account deficit over the medium term, it added.

On the country's foreign exchange reserves, the report said that various criteria confirm that official reserves are adequate for precautionary purposes.

As of the end of 2021, they represented about 223% of short-term debt on residual maturity and 195% of the IMF’s composite metric, it said.

Consequently, accumulation of additional reserves is less warranted, and FX interventions should be limited to addressing disorderly market conditions, the report said.