The country’s merchandise trade deficit widened to $14.2 billion in September from $10.8 billion in the previous month. The trade deficit for second quarter (July-September) stood at $37.3 billion compared to $29.3 billion a year ago and compared to $33.1 billion in the first of quarter of this fiscal (April-June). 

Accounting for the trade surplus in services ($17.8 billion in Q2) and assuming that remittances and investment incomes remain unchanged from last quarter, current account deficit (CAD) is set to widen to around $10 billion in Q2 from $7.8 billion in Q1. The widening is due to higher core (non-oil non-gold) imports, reflecting a gradual revival domestic demand, says a report by Crisil.

At $ 10 billion, CAD will be almost twice the levels seen a year ago (July-September 2013). The pick-up in trade deficit is mostly due to higher non-oil imports compared last year. During July-September 2013, gold imports had fallen sharply in a knee-jerk response to import curbs, which included a hike in gold import duty to 10% and a mandatory requirement that 20% of all gold imports be kept aside for exports. Imports of capital and consumption goods (non-oil non gold imports) too, have risen significantly (around 10% growth) compared to Q2 fiscal 2014, signaling a recovery in domestic demand from last year’s lows.

In September, export growth was weak at 2.7% y/y partly due to a high base. In contrast, imports grew at 26% y/y – their fastest pace in 2.5 years. Despite an over $10 per barrel decline in crude oil prices, oil imports rose by 9.7% due to higher import volumes. Non-oil imports also grew by staggering 36.2% y/y in September due to both higher gold and well as higher core (non-oil non-gold) imports.

Gold imports increased to $3.75 billion September – the highest monthly imports since curbs were imposed last August. Higher demand spurred by the upcoming festive season and low prices is likely to have led to the rise in imports of the yellow metal.

Mirroring domestic economic recovery, core (non-oil non-gold) imports also trended upwards for the fifth consecutive month - and much more sharply this time – growing at 22.3% y/y in September, up from 8.2% y/y in August. With core imports expected to pick up with economic recovery, exports need to raise its growth momentum in coming months to keep merchandise trade deficit in check.

The slowdown in exports was driven by a sharp decline in exports of petroleum products (13.3% y/y, fall) and electronic goods (17.4% y/y fall). These two sectors together account around one-quarter of India’s merchandise exports. In contrast, exports of engineering goods and ready-made garments continued to show robust growth at 20.2% and 15.9% respectively, in September.

Despite the expected widening in CAD in Q2, Crisil has revised down its forecast for India's CAD to $32 billion (1.5% of GDP) for 2014-15 from our earlier forecast of $47 billion (2.2% of GDP). The downward revision is due to lower oil prices and continued restriction on gold imports.

Crisil Research now expects oil prices to average $100 per barrel in 2014-15 as compared to the earlier forecast of $105 per barrel. Oil imports constitute nearly one third of India's total merchandise imports. Therefore, lower oil prices will significantly bring down total imports. With the Fed tapering nearing its end, any increase in interest rates in the US could trigger capital withdrawals from emerging economies including India. To reduce India's vulnerability to any such external shocks it believes that the government is likely to continue with import curbs on gold restrictions, which creates downside to its earlier forecast of gold imports.