The Coppers Are Thinning

Forex Reserves depleted by $10.4bn in Q2FY14, sharpest decline in last seven quarters, mainly due to decline in capital account balance. Capital account balance declined by $5.4 bn primarily driven by sharp FII outflow, outflows in foreign loans by commercial banks and decline of $6.9 bn in other capital. FII outflows increased sharply from Jun13 onwards, after Fed indicated high possibility of tapering of quantitative easing. FII outflows augmented further in Q2FY14 which amounted to $6.6 bn within which significant proportion of it was debt investment.

Outflow in other capital is indicating that exports receipts are received with significant lag. Strong FDI investment and increase in net overseas borrowing by banks aided in stalling the further decline in Capital Account Balance. Net trade credit outflow increased to $1.9 bn in Q2FY14 from inflow of $2.5 bn in Q2FY14 and $4.1 bn inflow in Q2FY13; with drop in imports in ensuing months, analysts expect trade credit to further shrink in subsequent quarters.

On the other hand, merchandise deficit narrowed down to 10 quarter low of $33.3 bn to 7.9% of GDP. Sharp growth in exports of 11.6% Y/Y in Q2FY14 as against 1.2% de-growth in previous quarter aided in driving the moderation of deficit. Export growth augmented on back of favorable currency and signs of improvement in global economy contributed largely by textiles and agricultural product exports. On the other hand, imports declined sharply on account of fall in gold imports and machinery imports. Strong action taken by government and RBI to curb gold imports has led to such a sharp correction in imports. Sharp depreciation in the currency, improvement

in global conditions and actions taken by government is likely to maintain favorable merchandise deficit for rest of the year.

Import as a ratio to foreign exchange reserves has further fallen to 6.6 months from a peak of 17 months in Jun04; this is mainly driven by sharper depletion in foreign exchange reserves despite substantial slowing down of imports. Increasing external vulnerability is indicated by falling import cover ratio. Software services exports increased to $16.3 bn due to favorable currency which pushed the overall services net exports to 4.3% of GDP. Net investment income declined by $6.4 bn in Q2FY14 on increasing servicing of rising external liabilities.

Higher reliance on short term inflows to finance CAD is likely to adversely affect net investment income and continue to pressurize CAD. While depreciating currency not only aided in increasing the inflow in private transfers but also augmented the growth in NRI deposits. To know more visit theFinapolis.com