Current account deficit continued its widening trend in Q1FY11, reaching USD 13.7 bn against ~USD 13 bn in the previous quarter. It was ~3.7% of GDP, which is on the higher side, historically. Among broad components of the current account, merchandise balance deteriorated, while invisibles improved compared with the previous quarter.
The monthly incoming trade data suggest that trade deficit continues to widen in Q2FY11 and, therefore, until invisibles improve markedly, current account deficit could widen even further in Q2FY11. On the currency side as well, while falling domestic inflation would help curb the real appreciation of INR; sustained inflows of foreign capital could put upward pressure on the nominal exchange rate.
The balance of payments risks are overdone. Analysts forecast the INR at Rs43.50/USD by March. The good news: higher capital inflows back our view that growth always funds itself. The bad news: there is still no respite for non-software services exports that declined US$2.6bn in the June quarter as well.
WPI & Inflation: At 8.5% in August, WPI inflation remains well above the RBI’s target range of 5%-6%. According to our forecasts, even though inflation may trend down gradually, the level will likely remain uncomfortably high. The monsoons may help primary article prices, but there is a structural component, which we think will prevent them from falling rapidly.