India's current account deficit predicted to narrow to US$12-13b

Exposure to external funding risks linger.

According to Morgan Stanley, India's current account deficit is predicted to narrow significantly in QE Sep-13, however exposure to external funding risks may remain in the near term.

Morgan Stanley expects current account deficit to narrow to US$12-13bn in QE Sep-13 (~2.7% of GDP annualized) vs. an estimated US$ 21bn in QE Jun (4.7% of GDP annualized).

Here's more:

While this brings us closer to the sustainable level of current account deficit at 2.5% of GDP, we would need to see trade deficit to sustain around 8-8.5% of GDP to achieve current account deficit at 2.5% of GDP.

In this context, we believe that outlook for the current account deficit will depend on (a) trajectory of CPI inflation, which is key to reduce gold imports (b) oil price movements and (c) external demand.

Indeed, in the context of reducing the funding risks, we believe that the most significant measure taken by RBI is to lift short-term real rates by 300bps in July (help increase saving to fund the current account deficit).

While the increase in real rates will help to narrow current account deficit over the next 4-6 months, in the interim India will remain exposed to funding risks.

What indicators to watch to assess funding risks: (a) Monthly trade deficit, (b) CPI inflation (c) measures to augment capital inflows and (d) US 10Y yields and US trade weighted dollar index.