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Thursday, May 29, 2025

Watchlist for investors

The macro environment in India looks stable and resilient, despite the scare of war and trade uncertainties. The south-west monsoon has started on a buoyant note, and IMD reconfirmed its forecast of above normal (106% of LPA) for the current season. Enhanced dividend payout by the RBI has lessened fiscal slippage concerns. Concerted efforts by the RBI to improve system liquidity have also yielded positive results. Fiscal strength, benign inflation outlook, and improved liquidity have resulted in the benchmark 10yr bond yields falling to the lowest level since 2021; reversal in FPI flows since March 2025; stability in currency and improved growth outlook.

Despite notable stability there are few areas of concern that investors should be mindful of. In particular, I shall be watching the development of external situations closely.

External situation - not worrying presently, but could deteriorate

India's external sector has shown resilience in recent years, but there are signs of strain. The merchandise trade deficit hit a near-record high of $26.42 billion in April 2025, driven by a 19.12% surge in imports outpacing a 9.03% export growth. This reflects a structural issue in India's trade balance, with heavy reliance on imported crude oil, gold, and electronics. While presently foreign exchange reserves are ~US$686 billion in January 2025, covering over 10 months of imports, the creeping depreciation of the rupee and global uncertainties (e.g., aggressive trade negotiation and geopolitics) add pressure.

The situation isn't critical yet, thanks to robust reserves and services exports, but the trend warrants caution as external vulnerabilities could escalate if global conditions worsen

Trade balance remains delicate

India's merchandise trade deficit for FY25 (April 2024–March 2025) has widened significantly, reaching $202.42 billion for the first eight months (April–November 2024), compared to $194.6 billion in the same period of FY24. This deterioration is driven by a faster rise in imports (8.3% growth to $486.73 billion) than exports (2.2% growth to $284.31 billion). November 2024 alone saw a record-high monthly deficit of $37.8 billion, fueled by a 27% surge in imports to $69.95 billion, largely due to a 4.3-fold jump in gold imports, alongside increases in electronics (17.4%), petroleum products (7.9%), and vegetable oil (87.8%). Exports, however, contracted by 4.8% to $32.1 billion in November, a 25-month low, partly due to declining petroleum prices.

The overall trade deficit (goods and services combined) is estimated at $94 billion for FY25, per posts on X, reflecting a structural imbalance. The trade deficit with China has surged to $99.2 billion, driven by an 11.5% rise in imports ($113.5 billion) and a 14.5% drop in exports ($14.25 billion). Conversely, India’s trade surplus with the US grew to $41.18 billion, with exports up 11.6% to $86.51 billion. The services trade surplus, estimated at $131.3 billion for April–December 2024, provides some relief, driven by strong IT and financial services exports. However, the current account deficit (CAD) is projected to widen to 1.4–2% of GDP in FY25, with Q3 FY25 potentially hitting 2.8% due to the November trade shock.

Trade deals with the UK, and potential trade deal with the US could impact trade balance negatively in the short term.

Despite intense efforts, India’s reliance on imported crude oil (88% of energy needs), gold, and electronics, alongside structural manufacturing gap, has not diminished materially. There have been some efforts to boost domestic manufacturing through monetary and fiscal incentives, but so far most of the investment has occurred in low value add businesses.

BoP Challenges

H1 FY25 (April–September 2024) BoP surplus was $23.8 billion, but 3QFY25 negative BoP of US$37.7bn on persistent FPI outflows and poor net FDI flows, raise some concerns over BoP for FY25; even though the projected current account surplus and potential stabilization in capital flows have shown promise in 4QFY25.

The BoP is expected to remain manageable, with a full-year CAD of 0.8–1.4% of GDP ($30–55 billion). A Q4 current account surplus could offset earlier deficits, but sustained FPI outflows and trade imbalances pose risks.

Global uncertainties (widening trade deficit, FDI slowdown, remittances slowdown due to the proposed remittance tax in the US, and domestic structural gaps pose strong headwinds for India’s BoP.

FDI slowing

Gross FDI Inflows in India were $81.04 billion in FY25, a 14% increase from $71.1 billion in FY24. FDI equity inflows rose by 45% to $29.8 billion (Rs. 2,58,873 crore) in H1 FY25 (April–September 2024), reversing three years of contraction.

However, net FDI inflows dropped to a record low of $0.353 billion in FY25, down 96.5% from $10 billion in FY24, due to large-scale repatriations and increased outward investments by Indian firms. Repatriations surged to $44.5 billion in FY24 and continued to be significant in FY25, driven by profitable exits through initial public offerings (IPOs) like Hyundai Motor and Swiggy, and divestments (e.g., Singtel’s Airtel stake, BAT’s ITC divestment). A key Swiggy investor reportedly earned over $2 billion post-IPO.

FDI slowdown could have some structural element as relative to GDP, net GDP has been declining for the past five years, and has fallen to the lowest level in more than two decades.

Net FPI equity flows negative since 2021

Net FPI equity flows (Primary market and secondary market) into India have been negative for the past four and half years (January 2021-YTD2025) now. A strong global liquidity event could perhaps reverse the trend, but so far there is little visibility of net FPI flows improving materially in the near term; notwithstanding the positive flows in the past three months.

Oil price and weaker USD offer some relief

Declining oil prices in early 2025 have eased pressure on India's import bill, given its heavy reliance on imported crude (85% of energy consumption). A weaker USD also reduces the cost of dollar-denominated imports and debt servicing. However, relying on these external factors is risky, as oil prices are volatile (e.g., influenced by OPEC decisions or geopolitical tensions), and the USD's trajectory depends on U.S. monetary policy. India needs to accelerate domestic energy production (e.g., renewables, green hydrogen) to reduce this vulnerability.

…but relying on externalities may not be a great idea

Dependence on favorable oil prices or a weaker USD is unsustainable, as these are beyond India's control. A stronger focus on structural reforms—such aggressive boost to manufacturing, enhancing export competitiveness, and reducing import dependency—would provide a more stable foundation. Additionally, diversifying trade partners and pursuing free trade agreements (e.g., with the EU, Japan) could mitigate risks from global volatility.

In conclusion, India's external situation is not yet alarming but shows clear signs of deterioration. The delicate trade balance, negative BoP, and volatile capital flows highlight structural weaknesses, particularly import dependency and sensitivity to global shocks. While forex reserves and services exports provide resilience, reliance on external factors like oil prices or USD weakness is risky. Fiscal slippages and food inflation add domestic pressures.

Tuesday, December 10, 2024

Do we need to worry about the external situation?

Notwithstanding a marked slowdown in the past few quarters, the Indian economy has managed to grow at a decent pace in the current global context. Though India may have lost the crown of the fastest growing global economy to Vietnam, it still remains the fastest growing amongst the top 10 global economies.

The Reserve Bank of India is holding US$658bn in forex reserves, which is considered adequate in normal circumstances or even in a usual cyclical slowdown. Despite accelerated selling in equity markets by the foreign portfolio investors (FPIs), the current account deficit of ~1.5% of GDP, is conveniently manageable. INR has been one of the most stable emerging market currencies. On the real effective exchange rate (REER) basis INR is presently ruling at a five-year high level.

In their recent policy review, the Monetary Policy Committee (MPC) of the Reserve Bank of India has cut growth estimates for FY25 by 60bps to 6.6% and 1QFY26 by 40bps to 6.9%. The MPC has also hiked their inflation forecast for 2HFY25 and 1QFY26. The RBI estimates are still few basis points higher than the average estimates of professional forecasters, as per the RBI’s recent survey. It is therefore likely that growth slowdown extends well into 1HFY26.

RBI has once again made it clear that it is not comfortable about the inflation trajectory and would prefer to outweigh price stability against growth in its policy dynamics. In the recent meeting, the two external members of the MPC voted in favor of a 25bps repo rate cut, but the RBI’s official nominees voted to maintain a status quo, despite loud growth concerns and political rhetoric for monetary easing.

The market consensus seems overwhelmingly in favor of a February 2025 repo rate cut. This assumes growth staying in the slow lane; lower food and energy inflation; and fiscal improvement as promised in the union budget for FY25. We need to watch for development of La Nina, adversely impacting the Rabi crop; slowdown in tax collection and rise in cash subsidies due to election promises adversely impacting the fiscal disincline. Compensating higher subsidies with a cut in capital expenditure (as has been the case in 1HFY25) would further slowdown the potential growth, making any monetary easing more inflationary.

At the surface level there is nothing that would ring alarm bells for domestic investors. However, some of the recent actions of the RBI are reminiscent of the 2013 crisis period. The monetary policy is increasingly sounding like a plan to secure the stability of USDINR.

I wonder if RBI is really worried or it is just cautious and taking preemptive steps to mitigate any chance of a balance of payment crisis and/or currency volatility.

I have taken note of the following data points; and at the risk of being labeled unnecessarily paranoid, I would keep a close watch on these for the next few months to assess any vulnerability in India’s external sector.

· There has been a marked slowdown in foreign flows -both portfolio flow and FDI flows in the past one year. The political changes in the US and Europe may further impact the flows in 2025. RBI may not want to further discourage flows by offering lower bond yields. For record, the India10y-US10y yield spread has already fallen from a high of 350bps in January 2024 to ~250bps.

· RBI has created a record short position in USD (over US$49bn in forward market) in the past couple of months to protect USDINR; besides running down Fx reserves by ~US$47bn in just one month (from US$705bn in October 2024 to US$658bn in November 2024)). It has taken almost US$96bn to keep USDINR stable in the 83-50-84.50 range.

It is critical to watch this because:

The global trade war could escalate, before it settles after the inauguration of President Trump. This could slowdown global trade; lead to China dumping on non-US trade partners; slowdown in remittances and services exports to some extent.

As the denominator (nominal GDP) goes down and exports also slow down, the current account deficit may show a tendency to rise, pressuring INR. The RBI cannot afford to spend another US$100bn on defending USDINR.

RBI has hiked the ceiling on interest rates offered by scheduled commercial banks on foreign currency deposits of NRIs. This is an early sign of the RBI worrying about Fx reserves. Any measure to limit foreign spending, investments (outward FDI) and LRS remittances will confirm these fears.

Presently, FPIs own about US$650bn worth of Indian equities, which is equal to official fx reserves of India. A US$12bn (appx 1.75% of total holding) sale in the past couple of months has caused some damage to the market sentiments. A 5% selling (US$35bn) could seriously damage equity markets, currency markets and RBI’s gameplan. Remember, on an average, we are running a ~US$20bn/month trade deficit; and a net external debt of over US$682bn. In a crisis situation, US$658bn reserves might not prove to be adequate.

· President-Elect Trump and some of his designated team members have explicitly termed India a “currency manipulator” and demanded RBI to strengthen USDINR. If RBI is forced to meet these demands, it may need to unwind its short USD position, conduct aggressive OMO to buy USD from the market, and engineer higher yields (bond and/or deposits) to attract more USD flows into India. This could make maintaining current account balance a challenging task. Especially in an environment, where China could be dumping everything in the global markets, and competitors like Vietnam, Indonesia, Philippines, Turkey are becoming very aggressive.

If you find it confusing, impertinent, misplaced, let me sum this up in short for you. I would prefer to totally avoid macro trades in 2025, and stay committed to individual business stories that I like.

Wednesday, December 4, 2024

To cut or not to cut

The 3-day bi-monthly meeting of the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) begins today. This would be the last meeting before presentation of the Union Budget for the year FY26. The members of the MPC would draw inputs from the latest national accounts (2QFY25 GDP data); October 2024 inflation data; October 2024 Professional managers’ survey results; September 2024 IIP estimates; November 2024 PMI and core sector growth data; April-October fiscal balance data; global developments (political and geopolitical); global inflation, rates, currency and market trends; expert opinions and views of the members of MPC; and assessment of the current and future situation provided by the staff of RBI.

The statement of the MPC on macroeconomic outlook and likely direction of the monetary policy will be a key input in preparation of the Union Budget for FY26. However, the market participants’ interest in the MPC meeting appears limited to whether, or not, at 10AM on 6^th December 2024, the RBI governor announces a repo rate cut and/or a cut in the cash reserve ratio (CRR). Some TV show panelists might also bother to note the downward revision, if any, in the growth estimates for FY25.

If the MPC decides to maintain a status quo on its policy stance – considering growth slowdown a temporary blip expecting a recovery from 3QFY25; and continue to accord higher weightage to still elevated inflation and highly uncertain and volatile global conditions, the market participants may be hugely disappointed.

Not to cut: In the October policy statement, the governor had adequately hinted about its preference for price stability over growth (see here). Perhaps RBI is much more conscious about the looming external threats, especially the balance of payment situation if there are sudden FPI outflows; or the FDI flows get restricted; or remittances are affected.

Or to cut: In the recent weeks, RBI has allowed USDINR to sustainably breach 84 mark. It appears that it may want USDINR to weaken further before Trump takes over the US presidency on 20^th January, and urges its trade-surplus trade partners to strengthen their currencies. We have seen a similar weakness in USDCNY also, for example. A token 25bps or an aggressive 50bps rate cut could drive USDINR to 86 in near term, providing RBI a leverage to engineer a ~5% USDINR appreciation to ~83 level in the next three months.

In either case, the transmission of the lower rates may not be in the corresponding measure, as RBI might continue to control credit growth and liquidity to reign inflation, asset quality and excessive unsecured lending. I therefore would not expect a CRR cut. I am however mindful that the market is pregnant with the hope of a CRR and/or repo rate cut and no action in this regard may lead to a sharp sell-off in financial stocks, especially NBFCs.

The market participants may also take note of the following three potential near term risks:

· Besides the real GDP growth, the nominal GDP growth has also fallen to 9% in the 2QFY25. A lower nominal GDP growth directly impacts the tax collections and corporate profitability. November manufacturing PMI is at 11 months low. Core sector growth has also been low in 3QFY25. Expecting an immediate revival of growth in 3QFY25 may not be prudent; and the RBI may not mind a transitory higher inflation to boost nominal GDP growth.

· The president-elect Trump has explicitly threatened the BRICS nations to refrain from any misadventure that would impact supremacy of USD. It may purely be rhetorical to gain some upper-hand in trade/sanctions negotiation with Xi and Putin. Nonetheless, it could cause higher volatility in the global markets. It becomes critical given that BRICS members supply two thirds of global fossil fuels.

· The outgoing president Biden has provided a complete pardon to his son, who was facing multiple criminal charges in the US. Biden had earlier categorically denied this favor to his son. Experts are interpreting this as an indication of rising fear of a widespread witch hunt by the Trump administration. The witch-hunt, if it does take place, may not remain restricted to the domestic political opponents of Trump.

Wednesday, September 25, 2024

State of the economy

The Reserve Bank of India (RBI) has issued its latest assessment of the state of the economy. The paper notes the marked slowdown in the global economy; it exudes confidence in the sustainability of 6.7%-7% GDP growth in India. In particular, the assessment sounds buoyant on manufacturing, and household consumption, while taking cognizance of resilience in the services sector. The inflation is forecasted to stay close to the lower bound of the RBI tolerance limit (4-6%).

Global economy slowing

The RBI paper highlights some areas of concern for the global economy. In RBI’s assessment global growth has lost some speed in the first half of 2024 relative to the preceding semester, and momentum has slackened further in the third quarter.

The paper notes, “All around, indicators point increasingly to slowing global economic activity, more so on the eastern shores of the Atlantic, which vindicated the ECB’s September rate cut to secure a soft landing. In the US, the now famous remark – “The time has come for policy to adjust” – has built up expectations that the economy is gaining prominence in monetary policy discourse. In China, even though consumer inflation has picked up modestly due to supply constraints related to extreme weather, weakening producer prices are fueling concerns that deflationary forces are taking root. A rising number of manufacturing industries face lacklustre demand alongside a deep property market downturn now into its third year.” In particular—

Job growth is getting softer than initially anticipated as labour markets continue to slow down, unemployment rates are ticking up and wage growth is easing, although historically high immigration is providing some offset. Consumer confidence surveys show a deterioration in sentiment about jobs.

Equity prices are still stretched but the crash in Nvidia’s stock in early September wiped out about US$ 300 billion in market value, hinting that the artificial intelligence (AI) overhype may be tapering off and expectations are catching up with reality.

Parched returns are drying up the venture capital ecosystem. Record volumes of corporate debt are being issued to head off the volatility triggered by worsening macroeconomic data, and to benefit from falling borrowing and refinancing costs.

OPEC plus has decided to delay a planned output increase as crude prices slumped below US$ 70 per barrel briefly on September 10, but it still plans to revive 2.2 million barrels per day of idle supplies over the course of 2025. Meanwhile, non-OPEC supplies are rising faster, and as the International Energy Agency warns in its September 2024 report, global oil demand is slowing sharply – electric vehicles are already displacing 1.8 million barrels of oil every day – and this is fuelling the sell-off in oil markets. In metal markets, the copper-gold price ratio is closing on to 4 – a rising ratio indicates higher industrial demand and hence a positive growth outlook.

Although upside pressures have likely been seen off, the pace of disinflation remains sluggish, provoking caution among monetary policy authorities about the pace of easing. In fact, the Governing Council of the ECB noted in its September meeting that inflation is expected to rise again in the latter part of this year, partly because previous sharp falls in energy prices will drop out of the annual rates.

Defying gravity, global merchandise trade volume continued to recover in the third quarter of 2024, according to the latest World Trade Organization (WTO) Goods Trade Barometer, amidst rising geopolitical tensions, ongoing regional conflicts, shifting monetary policy in advanced economies (AEs) and weakening export orders. Barring the sub-par performance of electronics, other components of global trade such as automotive products, container shipping and air freight are all firmly above trend, but new export orders are turning down, and raw materials have declined – causes for concern going forward.

EMEs are building up a growth rate lead over AEs to levels not seen in 15 years. Projections suggest that the proportion of EMEs other than China in which per capita GDP is likely to rise faster than the US is on course to surge from 48 per cent over the past five years to 88 per cent in the next five years.

In the recent period, the US dollar has weakened; historically, this has led to greater capital flows to emerging markets.

The global supply chain pressures index (GSCPI) increased in August 2024, rising above its historical average for the first time since November 2023. Geopolitical risks remained high due to continued tensions in the Middle East, albeit with a sequential moderation in August 2024. Supply disruptions have kept container shipping costs elevated, although they recorded some moderation during August-September 2024 from the peak levels recorded in July.

Domestic economy

The RBI sounds quite sanguine about the domestic economic growth, regardless of the soft 1QFY25 data. The paper cautions, “more needs to be read into the slowing of India’s GDP in Q1:2024-25 than just disappointment.” It points out that “The seasonally adjusted momentum of Q1 GDP was strong. Gross value added (GVA) growth actually rose sequentially in Q1, but the increase in subsidies – 3.6 per cent by the Union government and 26 per cent by the states – offset the gains from showing up in GDP growth.”

Household consumption is poised to grow faster in Q2 as headline inflation eases, with a revival of rural demand already taking hold.

The widening trade deficit and a spurt in overseas travel by Indians is likely to swing the current account balance from a small surplus in January-March 2024 to a deficit of 1-1.2 per cent of GDP in the first half of 2024-25. Capital flows in the form of portfolio debt flows, net FDI and non-resident deposits are providing comfortable financing.

Merger and acquisitions deals have been on the decline in the Asia-Pacific region in 2024, but India has emerged as a bright spot with an increase in volumes.

Agriculture suffered in Q1:2024-25 as India experienced the highest number of heatwave days in the summer of 2024, surpassing the previous high in 2010.

The underperformance of agriculture in Q1 was compensated for by a buoyant manufacturing sector and resilient services.

Global funds have been investing heavily in the Indian debt market for the fifth month in a row since May 2024. On the other hand, corporate debt issuances remained low during the financial year so far despite easing yields as issuers awaited the US rate cut.

In the credit market, with deposit mobilization becoming a challenge, banks continue to rely heavily on certificates of deposit to meet funding needs so that lagging deposit growth does not constrain credit. Banks are also offering higher interest rates on deposits, with more than two-thirds of term deposits earning 7 per cent and above. The gap between credit and deposit growth is, however, beginning to narrow. Non-banking financial companies are increasingly turning to offshore bonds. Microfinance institutions are facing some asset quality issues, warranting slowing down the pace of loan growth.

Headline CPI inflation came in below the Reserve Bank’s target for the second consecutive month in its August reading. This is a positive development, especially as the index has remained flat between July and August.

Surplus liquidity in the banking system moderated in the latter half of August, driven by build-up of government cash balances due to GST payments. In early September, however, a pickup in government spending led to the return of liquidity to the banking system. Overall, the average daily net absorption under the liquidity adjustment facility (LAF) decreased to ₹1.45 lakh crore during August 16 to September 17, 2024, from ₹1.52 lakh crore during July 16 and August 15, 2024.

Wednesday, June 12, 2024

Present Ok, future buoyant

The Reserve Bank of India (RBI) recently released the results of forward-looking surveys. Based on the feedback received from the respondents the survey results provide important insights with respect to consumer confidence, inflationary expectations and economic growth expectations.

Consumer confidence

The survey collects current perceptions (vis-à-vis a year ago) and one year ahead expectations of households on general economic situation, employment scenario, overall price situation, own income and spending across 19 major cities.

As per the survey results, Consumer confidence for the current period paused on its uptrend as sentiments on all parameters, except spending. The current situation index (CSI)2 moderated to 97.1 in May 2024 from 98.5 two months ago. (A value below indicates a state of pessimism)

However, for the year ahead, consumer confidence remained at elevated level in the optimistic terrain though it declined, albeit marginally, due to relatively tempered sentiments on the general economic situation and employment prospects. The future expectations index (FEI) stood at 124.8 in May 2024 (125.2 in the previous survey round).

Consumers expect higher rise in overall spending over the next one year vis-à-vis the previous survey round; more respondents expect an increase in both essential and non-essential (discretionary) spending.

Household inflationary expectations

Households’ inflation expectations for the three months and one year ahead periods increased by 20 basis points (bps) and 10 bps, respectively, but remained in single digits; their perception on current inflation, however, moderated by 10 bps and stood at 8.0 per cent in the latest survey round.

Higher share of respondents expected prices and inflation to rise for all major product groups over the next three months as well as one-year periods

At the aggregate level, female respondents had marginally lower inflation assessment and expectations than their male counterparts. Among occupation categories, self-employed respondents group expected highest inflation.

For one year horizon, households’ expectations on general prices remained closely aligned with their assessment related to food prices and housing.

Forecast on macroeconomic indicators

GDP: Real gross domestic product (GDP) is expected to grow by 6.8 per cent in 2024-25, revised up by 10 basis points (bps) from the previous round. It is expected to grow by 6.7 per cent in 2025-26, revised up by 20 bps from March 2024 survey round.

Forecasters have assigned highest probability to real GDP growth in the range 6.5-6.9 per cent for both the years 2024-25 and 2025-26.

Annual growth in real private final consumption expenditure (PFCE) and real gross fixed capital formation (GFCF) for 2024-25 are expected at 6.0 per cent and 8.6 per cent, respectively. Real gross value added (GVA) growth projection has been revised up marginally to 6.6 per cent for 2024-25 and kept unchanged at 6.4 per cent for 2025-26.

Inflation: Annual headline inflation, based on consumer price index (CPI), is expected at 4.5 per cent for both the years 2024-25 and 2025-26.

External sector: Merchandise exports and imports are projected to grow by 3.9 per cent and 5.2 per cent, respectively, during 2024-25 and by 5.1 per cent and 6.0 per cent, respectively, during 2025-26, in US dollar terms. Current account deficit (CAD) is expected at 1.0 per cent (of GDP at current market prices) during 2024-25 and at 1.1 per cent during 2025-26.

Thursday, May 2, 2024

Why to emulate Chinese investors?

Gold prices hit an all-time level in April and have corrected marginally since then. Again, this is the time when self-proclaimed investment gurus commemorate Indian households, especially the women, who have traditionally parked their savings in gold ornaments. They highlight how the uneducated and unaware “mothers” have managed to earn more return than savvy investors who invested in index funds etc. In my view, this narrative is completely flawed and does not merit any comment.

The all-time high gold prices in international markets have also triggered a deluge of reports forecasting a strong performance of gold in the coming years. The key arguments in favor of a strong rally in gold prices are (i) technical breakout; (ii) central banks amassing gold reserves in anticipation of the diminishing role of USD in the global economy; and (iii) the Dilemma of the Bank of Japan whether to protect bond yields or Yen. The traders have however pointed out that the higher gold prices are currently supported by the strong investor demand from China. The gold imports, other than the central bank buying, into China, have surged sharply in recent months and so have the trading volumes of gold in China.

In my view, gold is a declining asset and as such should offer sub-optimal returns in the decades to come. Particularly, for investors in a fast-growing economy like India, investment in gold makes little sense for household investors. It may be a bad idea for Indian investors to emulate their Chinese peers and invest in gold. Those advising Indian investors to invest a material part of their wealth (10% or more) in gold, because gold prices are likely to move higher due to buying by central banks and Chinese consumers/investors must consider the following:

· Chinese households are much richer and more protected as compared to Indian households. China’s per capita GDP (US$13136) is almost 5x of India’s per capita GDP (US$2731). Chinese households enjoy much more social security and a higher standard of basic amenities like education and health.

· The Chinese economy (US$18trn) is 5.3x in size as compared to the Indian economy (US$3.4trn). It is expected to remain much larger than India for the next 50 years at least, despite slower growth.

· China has forex reserves of US$3.23 trn as compared to India’s US$640bn. Though both countries have reserves close to 18% of their respective GDP, India runs a current account deficit of appx. US$100bn as compared to current account surplus of US$253bn for China. China needs to diversify from US and European treasuries and USD assets to protect its reserves from depreciating. For now gold is one of the popular option for it. India on the other hand does not have similar needs, given our current account deficit.

· The per capita income in China has grown at a CAGR of 6.1% over the last decade. In this decade, Chinese equities have provided a CAGR of 3.5% and real residential prices have barely risen. Whereas Gold in CNY terms has yielded a CAGR of 7.75%. However, for Indian investors, per capita income has grown at a CAGR of 5.3%, real property prices have grown 1.1% and equities have yielded a return of 11.4 CAGR. Chinese investors therefore have reasons to buy a hedge against inflation and negative real rates. The Indian investors on the other hand have little reason to diversify from high-yielding equities and positive real rate offering debt. Besides, they need to invest heavily in their education and health, unlike their Chinese peers.

Thursday, April 25, 2024

State of the economy

The recent RBI bulletin (April 2024) contains an interesting article on the current state of the economy. The article is written by officers of RBI and does not represent the official views of RBI.

The authors find most macroeconomic parameters positive and growth-supportive. The two areas of concern are climate and geopolitics. Overall, the global economy, and particularly the Indian economy, is stable and oriented towards resilient growth in 2024.

Some of the noteworthy points in the article could be listed as follows:

Global economy

Growth: Global growth remains resilient despite geopolitical challenges and extreme weather event risks. In its latest world economic outlook (WEO April 2024), the International Monetary Fund (IMF) raised the global growth forecast for 2024 to 3.2%, 10 bps higher than its January 2024 Update, and expected the global economy to grow at the same pace in 2025 in also. Advance Economies (AEs) are now expected to grow by 1.7% in 2024 against the forecast of 1.5% in January. Emerging Market and Developing Economies (EMDEs), the forecast has been revised up by 10 bps to 4.2%.

In March 2024 The global manufacturing PMI accelerated to its highest reading since July 2022 as new orders, output, and employment expanded. The manufacturing component reached a 20-month high; the services export orders index has remained in expansionary territory since January 2024.

Inflation: Headline inflation receded significantly from levels recorded a year ago in most economies, although it remained above targets. The global headline inflation is expected to fall from an annual average of 6.8% in 2023 to 5.9% in 2024 and further to 4.5% in 2025 (both revised up by 0.1 percentage points from previous projections), with AEs returning to their inflation targets sooner than EMDEs.

Consumer sentiment: Consumer sentiments continued to improve across geographies as inflationary pressures receded from year ago highs, supported by broadly stable employment prospects. Financial conditions remained accommodative on the back of strong equity market performance.

Trade: According to the UNCTAD Global Trade Update of March 2024, global trade is expected to gain momentum in 2024 after a decline of 3% in 2023. WTO in its Global Trade Outlook and Statistics – April 2024 projected world merchandise trade volume to grow by 2.6% in 2024 and 3.3% in 2025, following a larger-than-expected decline of -1.2% in 2023.

Monetary policy: Major central banks, especially in AEs, remained cautious, balancing the risks of cutting too soon against maintaining a restrictive stance for too long and hurting economic activity with financial stability risks. Most AE central banks held their policy rates constant in their latest meetings.

Treasury yields and mortgage rates are ticking up in major economies as expectations of interest rate cuts are being pared.

FDI Flows: A recent UNCTAD report estimated a modest rise in global FDI flows in 2023 over 2022, driven by two European countries (Luxembourg and Netherlands); however, excluding these countries, global FDI flows declined by about 18% in 2023. Amidst an uncertain global investment environment, India held its position as a favourable investment destination among peer Asian economies in 2023. India ranked fourth among EMEs in the 2024 FDI Confidence Index, reflecting continued optimism over its growth potential.

Domestic economy

The Indian economy continued to exhibit resilience amidst external headwinds which led to the build-up of supply chain pressures. Consumer confidence strengthened across parameters set out in the RBI’s latest survey of households. Enterprise surveys indicate that business assessment and expectations remain in positive terrain, with optimism on production, capacity utilisation (CU), order books, employment and overall business conditions. According to the economic activity index (EAI), economic activity remained resilient in Q4:2023-24, although available data indicate some moderation in March vis-à-vis the previous month on a seasonally adjusted basis.

Growth: The conditions are shaping up for an extension of the trend upshift that took the average real GDP growth above 8% during 2021-24. In order to achieve its developmental aspirations over the next three decades, the Indian economy must grow at a rate of 8-10 per annum over the next decade to reap the demographic dividend that started accruing from 2018 and, as calculations show, will last till 2055.

The domestic economic activity remains resilient, backed by strong investment demand and upbeat business and consumer sentiments. Headline inflation has come off the December peak; however, food price pressures have been interrupting the ongoing disinflation process even as shocks from adverse climate events and geopolitical tensions add uncertainties to the outlook. The Monetary Policy Committee of RBI, in its last meeting, projected real GDP growth for 2024-25 at a robust rate of 7%.

High-frequency indicators point to sustained momentum in domestic demand conditions in March 2024. As per the data from the Centre for Monitoring of Indian Economy (CMIE), the all-India unemployment rate (UR) fell to 7.6% in March, declining across both urban and rural regions. Agricultural prospects are expected to receive a boost amidst the IMD’s forecast of an above normal monsoon. Construction sector indicators reflected sustained growth in steel consumption and cement production. Available high frequency indicators for the services sector exhibited an optimistic picture in March 2024.

Inflation: Headline inflation moderated to 4.9% in March 2024 from 5.1% in February 2024. Core inflation eased further to 3.3% in March from 3.4% in February, the lowest in the current CPI (2012=100) series. The moderation was broad-based, with inflation softening across various sub-groups barring personal care and effects, and recreation and amusement. In terms of regional distribution, while CPI-rural inflation increased by around 10 bps to 5.4% in March, CPI-urban inflation moderated by 64 bps to 4.1%. Most of the states continued to record inflation in the range of 4-6%.

Food price uncertainties continue to weigh on the inflation outlook with the increasing incidence of climate shocks a key upside risk for food prices. Cost push pressures faced by firms are showing an upward bias and the recent firming up of international crude oil prices poses an upside risk to the path of inflation going forward. CPI inflation for 2024-25 is expected to be 4.5% with risks evenly balanced.

Financial Conditions: Liquidity conditions eased in March, with net liquidity adjustment facility (LAF) [including marginal standing facility (MSF)] injection narrowing to ₹0.29 lakh crore from ₹1.78 lakh crore in February 2024. Increased government spending and the RBI’s market operation smoothed system liquidity. While the buildup of government cash balances on account of GST collections and advance tax payments tightened liquidity intermittently, liquidity conditions turned into surplus towards March-end and early April in response to the increase in government spending. Overall, the Reserve Bank injected ₹4.16 lakh crore cumulatively into the banking system during March 16 - April 19, 2024.

Reflecting these liquidity developments, the weighted average call rate (WACR) – the operating target of monetary policy – has remained within the policy corridor since the February policy meeting, barring the usual year-end spike.

Across the term money market segment, yields on 3-month treasury bills (T-bills), certificates of deposit (CDs) and commercial papers (CPs) for non-banking financial companies (NBFCs) eased towards end March and early April. The average risk premia in the money market (3-month CP minus 91-day T-bill) reduced to 98 bps during March 16 – April 19, 2024 from 141 bps during February 16 - March 15, 2024. While short-term rates moved in tandem with the evolving liquidity developments, long-term rates remained largely stable. Corporate bond yields generally softened and risk premia narrowed during March 16 to April 19, 2024.

External conditions: India’s foreign exchange reserves reached an all-time high of US$ 648.6 billion on April 5, 2024. As on April 12, 2024, India’s foreign exchange reserves stood at US$ 643.2 billion, sufficient to cover for 99% of total external debt outstanding at end-December 2023.

India’s current account deficit (CAD) improved to 1.2% of GDP in Q3:2023-24 from 1.3% in Q2:2023-24 and 2.0% in Q3:2022-23. Robust services exports and strong remittance receipts eased merchandise import pressures on the current account in Q3:2023-24. Net capital inflows exceeded the CAD, supported by robust FPI and banking capital, leading to an accretion of foreign exchange reserves on a balance of payment (BoP) basis (excluding valuation effects) to the tune of 6.0 billion during the quarter.

At end-December 2023, India’s external debt stood at US$ 648.2 billion; the external debt to GDP ratio declined to 18.7% at end-December 2023 (at end-September 2023 it was 18.8%). India’s external sector exhibited resilience, indicated by sustainable levels of key vulnerability indicators at end-December 2023.

Currency: The Indian rupee (INR) depreciated marginally by 0.04% (m-o-m) vis-à-vis the US dollar in March 2024 while remaining one of the least volatile major currencies.

Climate challenge

Global weather agencies are in agreement that March 2024 was the warmest March since record-keeping began in 1850 – global surface temperature was at 1.6 degrees Celsius (3.01°F) above the 1880-1899 period.

The World Meteorological Organisation (WMO) sounded a red alert about global warming in its latest report “State of the Global Climate 2023”, stating that there is a high probability that 2024 will breach the threshold set in 2023 as the hottest year on record even as the world careens towards a freshwater shortage crisis. According to the WMO report, “data from the Indian Meteorological Department (IMD) reflects a worrying escalation in extreme weather events necessitating an urgent and collective response.”

Central bank conundrum

Central banks continue to speak in cautious tones about growth prospects in 2024 as they deal with the interest rate conundrum. Regime shifts are underway in the form of exits from negative interest rates and their unintended consequences. Expectations of interest rate cuts are being pared where they have not yet commenced in recognition of the risk of moving too fast and turning disruptive if inflation moves up again with the lift provided by buoyant economic activity. Switzerland became the first AE to cut interest rates, reflecting a wariness of currency appreciation and an eagerness to join the growth party, given that inflation is well within the tolerance band.

Tuesday, April 2, 2024

FY24 – Resilient growth and positive sentiments

FY23 was mostly a year of normalization. After two years of disruptions, uncertainty, and volatility, both the markets and the economy regained a semblance of normalcy in terms of the level of activity, trajectory of growth, direction, and future outlook.

Building on the momentum regained in FY23, the Indian economy and the markets made a steady move forward in the financial year FY24. The resilience of growth has been surprising, given the tighter money conditions and challenging external environment.

The global economy was also stable despite geopolitical and climate challenges. Global markets accordingly performed well. The sentiments remained mostly positive and supportive of risk.

The following are some of the highlights of the performance during FY24.

Equity Markets

Indian equity market was amongst the best-performing global markets. The benchmark Nifty yielded a return of ~29% (27% in USD terms), which was in line with the US markets (S&P500 +28%), but much higher than Europe (Stoxx600 +12%; DAX +18%).

Asian markets were mixed. Japanese equities were the top global performers (Nikkei255 +44%); South Korea (KOSPI +17%) did reasonably well; while China (Shanghai Composite -7%), Singapore (-14%) and Hong Kong (Hang Seng -19%) ended the year with major losses.

Broader markets at the center stage

The primary action was away from the benchmark Nifty. Broader markets sharply outperformed the benchmark in one of their best years in the past decade. Nifty Smallcap 100 (+70%) and Nifty Midcap 100 (+60%) led the market gains.

The overall market cap was higher by 50% yoy against Nifty50 gaining 29% (81% of total market cap) and Nifty500 gaining 39% (91% of total market cap). Some part of the gap could be explained by new listings, but most of this is attributable to the massive outperformance of smallcap stocks.

Sector-wise, Realty, PSU Banks, Auto, Energy, Infra, Pharma and Metal stocks were top outperformers. Financials (ex PSU Banks), FMCG, IT Services were notable underperformers. Micro-sector-wise, renewable energy stocks were outstanding while chemicals were the worst performers.

Nifty consistent performer; broader markets more volatile

The benchmark Nifty50 yielded positive month-on-month returns for nine out of twelve months in FY24. However, the market breadth was negative in five out of twelve months implying much higher volatility in the broader markets.

Institutional flows positive, Nifty-Flow correlation breaks in 4QFY24

Institutional flows were materially positive for FY24. Net domestic and foreign flows in the secondary equity market amounted to Rs3609bn. Foreign Portfolio Investors (FPIs) were net buyers of Rs1510bn while domestic institutions pumped in Rs2099bn. FPIs were net sellers in four out of twelve months. The nifty-institutional flow correlation however completely broke down in 4QFY24 when Nifty gained less than 3% despite Rs1042bn of net institutional flows.

Debt and Currency Markets

Indian debt and currency markets were mostly stable during FY24, showing little volatility. RBI did not make any changes to the policy rates.

The benchmark 10-year treasury bond yields eased to 7.05% from 7.3% a year earlier. USDINR weakened 1.8% to 83.37 from 81.87 a year earlier. Lending and term deposit rates were higher by up to 50bps. The yield curve shifted lower and flattened completely.

The RBI continued with its “withdrawal of accommodation” policy stance. The liquidity position therefore remained tight for most of the year. The credit growth outstripped the deposit growth. Overnight and call money rates were accordingly higher by 70-90bps.

Economic conditions

Overall GDP growth was consistent and strong for the first three-quarters of FY24. Beating all forecasts and consensus estimates, FY24 GDP is poised to show a growth of over 7% yoy. FY25 GDP growth estimates have accordingly been upgraded.

· CPI Inflation mostly remained within the RBI’s tolerance band of 4-6% (except for a short spike in 1QFY24). Core inflation eased below 4% in 4QFY24.

· Real rates have mostly remained in positive territory during FY24.

· Private consumption, household savings, and government consumption expenditure were some of the distinct areas of slowdown.

· Project awarding activity witnessed a marked slowdown in 2HFY24.

· Rural markets gave mixed signals of demand recovery. For example, farm tractor sales declined again in 2HFY24, while 2w-3w sales staged some recovery. FMCG companies’ commentary remained mostly cautious about the consumption demand recovery in rural areas.

· External conditions were broadly good. The current account balance was manageable at 1.2% of GDP during 9MFY24, supported mostly by services and remittances. Merchandise trade balance remained negative.

· Electronics (6.5% of total exports) and Pharmaceutical (6.3% of total exports) registered good growth, while traditional petroleum products, gems and jewelry, and textiles recorded materially negative growth during 9MFY24.

· Net FDI flows continued to decline for the third consecutive year.

Commodities

FY24 was a mixed year for commodities. Precious metals (Gold +15%) and crude oil (Brent 10%) recorded decent gains, while industrial metals (Nickel -30%, Zinc -17%, Steel -19%), natural gas (-21%), coal (-28%), and agri commodities (Wheat -19%, Soy -21%) ended the year with strong losses.

Crypto shine

Cryptocurrencies like Bitcoin staged a massive recovery during FY24, ending the year at all-time high levels. The newest asset category gained a wider acceptance during the year from market participants and regulators.