Mali Chivakul, emerging markets economist at J.Safra Sarasin Sustainable Asset Management, delivers latest update and outlook for investment in India
India’s growth remains resilient. Its 1Q GDP growth surprised to the upside, driven by capex spending and services industry. On the external front, the current account deficits moderated significantly, aided by lower energy prices and robust services exports. On the domestic front, inflation has eased back to the Reserve Bank of India (RBI)’s comfortable zone.
While the RBI’s preference of replenishing its international reserves could keep the Indian rupee (INR) stable in the near term, the improvement in the balance of payments flows should lend to stronger INR over time. The RBI may start lowering its policy rate later in the year if food prices remain stable and the risk that the Fed will have to increase its policy rate further subsides.
When we wrote about India in February, we highlighted the capex-driven growth but were worried about its large current account deficits due to high energy prices. Since then, capex-driven growth has remained strong. GDP in the first quarter at 6.1% yoy surprised to the upside, driven by strong capex spending while consumption growth was rather weak at 2.8%, suggesting that the pandemic scars remain at the household level. Gross fixed capital formation as a share of GDP continues to climb back from its low point reached during the pandemic. Strong budget execution should help propel capex growth for the rest of the fiscal year.
The worry on India’s external front has however largely disappeared. We expected in February that the current account deficit could remain around 3% of GDP. Lower energy prices as well as a surge in services exports have lowered the deficit towards 2% of GDP. Despite a fall in goods exports, the trade balance has greatly improved in the last few months as the cost of importing oil has fallen significantly.
The surge in services exports has been impressive at almost 30% from 2021 to 2022, reaching $309 billion or 40% of total exports of goods and services. The surge followed a significant increase in foreign direct investment in business services in recent years as many global companies established their global business service centers in India. While its growth is tapering off this year, services exports should still give a decent lift to the external account.
On the domestic front, inflation has also dropped to a reasonable level. Headline inflation reached 4.3% in May, driven by food inflation (3.3% yoy). This is close to the Reserve Bank of India (RBI)’s target of 4%. Even core inflation slowed to 5%. If the risk of higher food prices due to El Nino effects on the monsoon rainfalls does not materialise, the RBI could have an opportunity to start lowering its policy rate later in the year (the monsoon season is June to September). The RBI will also be watchful of the possibility that the Fed may still need to increase its policy rate further. Such risks will likely keep the RBI on hold for longer.
We expect the RBI to continue intervening in the FX market and accumulating international reserves in the near term. Despite substantial improvement on the current account front, the RBI remains cautious and is proactive at FX management. Reserves currently stand at almost $600 billion, compared to $640 billion at the peak in 2021. This implies that the RBI could reach the previous peak in the next few months.
One could also argue that the RBI’s reserves target level should be lower than in early 2022 given where we are in the global cycle (Fed’s tightening to end soon) and India’s lower current account deficit. While the Indian rupee (INR) will likely be stable in the near term, we expect it to strengthen over time given the current account improvement and the expectations of higher foreign direct investment and portfolio investment. Indeed, equity inflows have improved since the fallout of the Adani scandal early this year. Indian equities have benefited
