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Wednesday, July 9, 2025

India’s US$736.3bn debt challenge: Can it weather a US tariff storm?

India’s external debt hit US$736.3bn by March 2025, a 10% jump from last year, with a significant portion (over 41%) of the debt maturing soon. As the US threatens 500% tariffs on countries buying Russian oil, including India, investors need to evaluate: Can India afford a confrontation with the US, China and other major trade partners, and could it withstand a covert economic embargo? Here’s my take, may be naïve and ill informed, but nonetheless relevant.

India’s External Debt

According to the Reserve Bank of India (RBI) latest release, India’s external debt stood at US$736.3bn at the end of March 2025, with a debt-to-GDP ratio of 19.1%. Key highlights of the data are:

Long-Term Debt: US$601.9bn, up US$60.6bn from last year, with commercial borrowings and non-resident deposits driving growth. About 77% (US$568bn) of this debt is owed by non-government entities. The non-government debt is almost equally divided between financial institutions (US$271.3bn) and non-financial corporations (US$261.7bn).

Short-Term Debt: US$134.5bn, representing 18.3% of total debt and 20.1% of foreign exchange reserves.

Components: About one half of external liabilities (US$251bn) is loans and debt securities, 22% currency and deposits and 18% trade credit. The rest 10% includes IMF SDRs and intercompany lending by MNCs.

Maturity: 41.2% of the external debt (about US$305bn), is due to mature within the next 12 months.

Debt Sustainability: Foreign exchange reserves cover 92.8% of total debt, down from 97.4% a year ago, signaling a slight decline in buffer capacity.

Refinancing challenge

With over 40% of long-term debt maturing soon, India faces a refinancing challenge, particularly if global financial conditions tighten or trade disruptions escalate. India’s reliance on Russian oil, which accounts for 35-40% of its crude imports (2.08 million barrels per day in June 2025), has put it in the crosshairs of a proposed US Senate bill. The “Sanctioning Russia Act of 2025,” backed by Senator Lindsey Graham and reportedly supported by President Trump, proposes a 500% tariff on countries importing Russian energy to pressure Moscow over Ukraine. India, alongside China, buys 70% of Russia’s oil exports, making it a prime target.

Economic Impact: A 500% tariff on Indian exports to the US, India’s largest export market, could affect US$66bn (87% of India’s US exports), as per Citi Research estimates. This could disrupt key sectors like pharmaceuticals, IT, and textiles, potentially triggering inflation and job losses.

Oil Dependency: India imports 88% of its crude oil, with Russia offering competitive discounts. Switching to costlier suppliers like the US or Middle East could raise import costs significantly, straining India’s trade balance.

Can India Afford a Confrontation?

India’s economic fundamentals offer some resilience but also expose vulnerabilities.

Forex Reserves: At US$703bn (as of recent data), India’s reserves cover 92.8% of external debt, providing a cushion to manage maturing obligations. However, refinancing US$270.9bn in long-term debt within a year could pressure reserves, especially if US tariffs disrupt export revenues.

Trade Dynamics: The US accounts for a US$45.6bn trade deficit with India. A trade war could prompt reciprocal tariffs, but India’s 12% trade-weighted average tariff (vs. the US’s 2.2%) limits its leverage. Negotiations for a trade deal to cut tariffs on US$23bn of US imports are underway, signaling India’s preference for diplomacy over confrontation; notwithstanding some recent comments of senior ministers that suggest otherwise.

Oil Alternatives: India has diversified its oil imports, with the US supplying 6.3% (439,000 bpd in June 2025) and West Asia 35-40%. While switching from Russian oil is feasible, it would increase costs, potentially impacting fuel prices and inflation.

Can India Sustain Virtual Economic Sanctions?

Virtual economic sanctions, such as the proposed 500% tariffs, or Chinese embargo on export of critical components, chemicals, human resources etc., would act as a severe trade barrier.India’s ability to sustain them depends on several factors.

Energy Security: India’s strategic reserves (9-10 days of imports) and diversified suppliers (US, Nigeria, Middle East) provide short-term flexibility. However, replacing Russia’s 40% share at higher costs could strain refiners and consumers.

Economic Resilience: The RBI’s Financial Stability Report (July 2025) highlights strong banking sector metrics, with declining non-performing assets and robust capital buffers. This suggests India’s financial system could absorb some shocks, but prolonged trade disruptions could erode confidence.

Need for caution

India’s debt remains manageable for now, but over 41% debt maturity in 12 months calls for vigilance. Investors in Indian bonds or banking stocks should monitor refinancing risks.

A US tariff war could hit export-driven sectors like IT and pharmaceuticals hardest. India’s diplomatic efforts to secure a trade deal or tariff waiver will be critical. A successful negotiation could stabilize markets, while failure could spark volatility.

Conclusion

India’s US$736.3bn external debt and looming maturities pose challenges, but its reserves and diversified oil sources provide a buffer. A full-blown confrontation with the US seems unlikely, given India’s diplomatic push and economic stakes. However, sustaining virtual sanctions would strain India’s trade balance and energy costs, making de-escalation the smarter play.

The 41% of external debt (US$305bn) maturing within 12 months is significant, requiring substantial refinancing or reserve drawdowns. India’s US$703bn forex reserves provide coverage, but a US tariff war could reduce export revenues, complicating debt servicing.

Sustained 500% tariffs would disrupt exports, weaken the rupee, and increase debt servicing costs. The RBI’s strong banking sector provides some stability, but prolonged sanctions could erode investor confidence and slow growth.

India’s neutral geopolitical stance and trade deal negotiations (aiming to cut tariffs on US$23bn of US imports) indicate a strategy to avoid sanctions. A waiver or partial exemption is possible, given India’s strategic importance to the US.

Read with US$703bn may be just enough

Tuesday, July 8, 2025

US$703bn may be just enough

The Reserve Bank of India holds US$702.78bn in foreign exchange reserves. In the popular macroeconomic analysis, especially in the context of the equity market. this piece of data is often used as one of the points of comfort by analysts.

This data could be viewed from multiple standpoints. For example –

Is it adequate to pay for the necessary imports in the near term, assuming the worst-case scenario of no exports could be made and no remittances are received. Currently, India’s monthly imports are appx US$67bn. However, a material part of these imports is crude oil and bullion. A part of the crude oil and bullion is re-exported after refining/processing. I am unable to figure out the precise net import number for domestic usage, but it would be safe to assume that about three fourth of US$67bn, i.e., US$50bn is for domestic usage. Allowing another 20% for “avoidable in emergencies” category of imports, we have appx US$40bn/month import bill payment obligations. By this benchmark we have sufficient reserves to pay for appx 18months of imports. This is a very comfortable situation from conventional yardsticks.

However, we need to consider interest payment and debt repayment obligations also to assess the adequacy of the foreign exchange reserves.

As per the latest RBI release (see here), India’s total external liabilities stood at US$736.3bn as on 31^st March 2025. 41.2% or appx US$305bn of this debt is due for repayment within the next 12 months. Assuming an average interest rate of 5%, another ~US$35bn would be needed for interest repayments. This implies about half of our foreign exchange reserves are needed for debt servicing in the next 12 month. This matrix raises some questions on the adequacy of our US$703bn reserves.

It also highlights the importance of remittances (appx US$135bn in FY25), foreign portfolio investment (FPI) flows (appx US$13.6bn in CY2024, including equities and bonds), and net foreign direct investment (US$3.5bn in FY25). An adverse movement in any of these flow matrices could materially affect the external stability. This brings in the factors like geopolitical stability, internal political & law and order situation, relative valuations of Indian equities and bonds, market stability and integrity, domestic investment climate, foreign investment policy framework etc. into the picture. Any policy mistake, strife in foreign relations, civic unrest, overvaluation, fraud, scam etc. could adversely impact the external stability.

The news headlines like - “China restricting export of critical components and chemicals to India, withdrawing expert manpower from India” that can adversely affect exports or increase the cost of imports for Indian manufacturers; the US considering to impose tax on the outward remittances”, ‘the US considering 500% duties on countries importing oil from Russia”, etc., - makes one cautious about the external stability of the country.

The experts need to analyze the latest RBI data on India’s external liabilities. In particular, it needs to be assessed whether India can withstand a trade war with the US; a covert geopolitical confrontation with China; frequent cases of market manipulation; policies and procedures that make India a less attractive destination for foreign investments; worsening law & order situation on parochial issue like language, religion, regionalism, etc.

…more on this tomorrow

Wednesday, June 18, 2025

Where did we lose our way?

My engagement with Indian financial markets began in the late 1980s, at a time when the winds of reform had just started sweeping through the economy. What followed in the 1990s was a structural reset — the kind that lays the foundation for decades of growth, even if its full implications aren’t immediately visible.

The decade of 1990s witnessed –

(i) An overhaul of the financial sector with abolition of capital controls, opening of doors for the foreign portfolio investors, entry of private banks in the markets, material liberalization of the rules for non-bank lenders (NBFCs); laying foundation for pension and insurance sector reforms;

(ii) Significant liberalization of the industrial licensing system; material dilution of the Monopolies and Restrictive Trade Practices Act and Foreign Exchange Regulation Act, de-reservation of several articles from Small Scale Industries, introduction of Liberalized Exchange Rate Management System (LERMS), etc.;

(iii) India becoming a signatory of the World Trade Organization. (Of course, India was a signatory to the GATT since 1948);

(iv) Simplification of excise classifications, introduction of VAT and MODVAT, material reduction in maximum marginal rates of IT Act and simplification of rules;

(v) Beginning of disinvestment and divestment process in public sector enterprises (PSEs). The government initiated disinvestment of its stake in many non-strategic PSEs. More importantly, the government divested government monopolies in core sectors like Oil& gas, Power, Coal, Roads, Ports, Civil Aviation, Communication, etc.

(vi) India gained recognition as a major center of information technology (IT) and pharmaceutical research and development center in the world. For the first time, thousands of Indian professionals (Software Engineers & developers, Bankers, doctors and Managers) started working and travelling across the globe, unlike decades when Indian worker mostly got low paid blue-collar jobs.

(vii) Strategically, India was recognized as a country having a nuclear deterrent. Significant advances were made in development of missile and space research technologies.

All these developments gain higher importance when we consider that this was the era of significant political instability (minority governments 1989-1995, and then three general elections during 1995-1998) and financial constraints (Balance of Payment crisis in early 1990s, economic sanctions post nuclear tests in 1998, massive stock market scams, financial sector crisis and bankruptcy of multiple development financial institutions like UTI, IDBI, ICICI, IFCI).

More notably, till 1990 Indian and Chinese economies were mostly at par. We could even say that India had a marginal edge over China as it had wider global acceptance due to its democratic traditions. China also started its economic transformation around the same time. In 35 years, the Chinese economy has sprinted miles ahead of the Indian economy. No one, not even Indian politicians, is claiming that we are even in the race to bridge this gap in the foreseeable future.

This morning, I am writing this after reading about 20 equity research reports. All these reports, without even a single exception, have expressed worries about inflation and CAD due to the spike in crude oil prices in the global markets. It felt like déjà vu.

Back in 1990-91, as the Gulf War broke out, crude prices spiked and sparked the same anxiety. Three decades on, monsoon dependency and crude oil shocks remain headline risks for the Indian economy. Three decades later, nothing seems to have really changed - we’re still haunted by monsoon uncertainties and oil shocks.

Despite a decade of brave reforms and a globalized capital base, India’s macro vulnerabilities remain eerily similar. Our reforms deepened markets and broadened participation, but left key structural risks unaddressed.

So, the question we need to ask is “where did we lose our way in the past couple of decades?”

To me, India’s growth story remains compelling, but ignoring its macro vulnerabilities is difficult. The past teaches us resilience but the future demands vigilance.

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.