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India's Current Account Good News May Be Fleeting

Indian Rupees
Robert Clare | Getty Images
Indian Rupees

India's current account deficit narrowed sharply in the first quarter of the year, but the rapidly-falling rupee could threaten the balance going ahead, analysts said.

For the first three months of the year, India's current account deficit narrowed to $18.1 billion or 3.6 percent of GDP, as non-oil and non-gold imports fell due to slowing growth, figures from the Reserve Bank of India (RBI) showed on Thursday.

This compares to the eye popping $32.6 billion, or 6.7 percent of gross domestic product (GDP), recorded in the final quarter of 2012.

But the quick decline of the rupee, which has been one of the world's worst performing currencies over the past month, could threaten to widen the current account gap going forward,as capital continues to flow out.

(Read More: Diving Rupee—Here's How Bad It Can Get for India )

Vishnu Varathan, market economist at Mizuho Bank, described the narrowing deficit as a "fleeting relief."

"How hollow a relief it will be remains to be seen. The second quarter is likely to look worse than the first if nothing changes from now," he said.

The current account deficit for the full financial year ended March 2013 was at a record high 4.8 percent of GDP.

(Read More: Why Market Watchers Aren't Giving Up on India )

Even though a weaker domestic currency theoretically should boost a country's exports and decrease appetite for imports, Varathan said this is an unlikely case for India.

"A weak rupee could compound worries in so far that export benefits are muted, but risks associated with imported inflation and further pressure on the fiscal position [could] intensify," he said.

Commodity and gold imports constitute a large part of India's trade bill and a depreciating rupee will makes these purchases more expensive.

Domestically-focused Indian corporations with foreign borrowings will feel the pressure from a depreciating currency as well.

"External debt will now be more expensive for everyone, but particularly in the corporate sector, it will be a clear negative for them, as they have taken on a reasonable amount of debt," said Robert Prior-Wandesforde, director of non-Japan Asia economics at Credit Suisse.

"It [a weaker rupee] will be a positive for exporters, who will benefit from a more competitive exchange rate. So the ones that will be hit hard are those that have taken on a lot of external borrowing and are not exporting a lot and more focused on domestic demand," he added.

The rupee has lost roughly 12 percent since the start of May against the U.S. dollar, as anxiety over U.S. Federal Reserve tapering led foreign investors to dump emerging market assets and buy the dollar. Plus India's slowing growth, which likely hit 5 percent in the 2012/2013 fiscal year, its slowest in a decade, has kept investors away.

(Read More: India Unhappy, but Unshaken by Rupee's Plunge )

The better than expected current account deficit data boosted the currency roughly 0.5 percent to 60.31 percent against the U.S. dollar early on Thursday. The data was released a day early in a move that some have suggested was deliberately made by the RBI in an effort to calm volatility in the currency.

However, analysts told CNBC they expected further weakness in the rupee. "We expect more rupee weakness though it won't go in a straight line," said Rajeev Malik, senior economist at brokerage CLSA. "A stronger US dollar, higher U.S. bond yields and the evolving adverse outlook for global capital flows will cause the rupee to depreciate."

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