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Trade deficit widens, reserves under pressure
Merchandise trade deficit at $68.5 billion in Q1 was higher than $63.8 billion in the corresponding period a year ago. In the current quarter (July-September), the trade gap could be higher – in July, it stood at $27.35 billion, much higher than $18.7 billion in June.
The reserves accretion could be weaker or even negative in the current quarter, due to a combination of higher CAD and weaker capital inflows.
Foreign portfolio investors pulled out nearly $4 billion from Indian equities in August alone, the sharpest sell-off in six months. Punitive tariff on Indian goods by the US and the falling rupee have apparently influenced the sell-off. With exports likely to be affected by the US tariff, trade deficit could remain elevated.
According to a statement by the Reserve Bank of India, net services receipts increased to $47.9 billion in Q1 this fiscal from $39.7 billion a year ago. Services exports have risen on a y-o-y basis in major categories such as business services and computer services.
Net outgo on the primary income account, primarily reflecting payments of investment income, increased to $12.8 billion in Q1 from $10.9 billion a year ago. Personal transfer receipts, mainly representing remittances by Indians employed overseas, rose to $33.2 billion in Q1 from US$ 28.6 billion a year ago.
Remittances and FDI inflows provide support
In the financial account, foreign direct investment (FDI) recorded a net inflow of $5.7 billion in Q1 as compared to a net inflow of $ 6.2 billion a year ago.
Foreign portfolio investment (FPI) recorded a net inflow of $1.6 billion in Q1 as compared to a net inflow of $0.9 billion in Q1FY25.
Net inflows under external commercial borrowings (ECBs) to India amounted to $3.7 billion in Q1 as compared to $1.6 billion in the corresponding period a year ago. Non-resident deposits recorded a lower net inflow of $ 3.6 billion in Q1 compared with $4 billion a year ago.
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“While India’s current account expectedly reverted to a deficit in Q1 FY2026, the extent of the same was considerably lower than our projection (~$7 billion). The surprise was largely driven by larger than anticipated remittances, which surged by ~18% on a YoY basis in the quarter. This augurs well, given the uncertainty that lies ahead given the recent tariff-related developments,” wrote Aditi Nayar, chief economist at Icra.
Considering that ~50-60% of India’s exports to the US are at risk, the downside is likely to be material in case the 50% tariff rate (25% general + 25% special) is continued until the end of FY26, she noted. “Given this, India’s exports to the US are likely to contract during the remainder of the fiscal. In this scenario, we expect India’s overall merchandise exports to decline somewhat in FY26 from the levels seen in FY2025, and for the current account deficit to exceed 1% of GDP, while remaining at moderate levels.”