Current account to widen, commodities a key driver
After registering a surplus in FY21, India’s current account balance returned to red in FY22 (year ended Mar 2022) to the tune of -1.2% of GDP. This wider gulf was due to a doubling in the merchandise trade deficit in FY22, which offset the increase in invisibles on higher service earnings and remittance flows. Under financial flows, net FDI moderated to US$38.5bn (vs FY21’s $44bn) besides portfolio outflows of -$16bn vs strong inflows of $36bn year before (see table at the end of the report). Weak fund flows were negated by a sharp increase in net external commercial borrowings to $7.4bn vs $0.2bn year before, likely as firms tapped low borrowing costs. Other capital flow segments also jumped on account of one-off IMF SDR flows the year.
Netting off the current and financial flows, the overall balance of payments was positive, resulting in a net accretion to foreign reserves. Basic BOP i.e., current account plus net FDI was a minor negative at -$6bn, reversing from a significant surplus year before.
In FY23, a higher commodity import bill and tight global financial conditions will likely pressure the external math. We expect the FY23 current account deficit (CAD) to widen to -3.2% of GDP, the widest since 2013, vs -2.7% projected earlier, with the balance of payments to slip back to red after three years of surplus.
These revisions are premised on:
The 2H trend might run into rough weather on recessionary concerns in the US and muted Europe, slowing the pace of full-year growth. The correlation of India’s export growth to global GDP growth is 0.6, and higher at 0.74 to the world’s exports. Concurrently, the impact of restrictive domestic policies might also yield a result e.g., a ban on wheat, temporary action on sugar, and export duties on iron & steel. We expect nominal exports to rise 10% yoy this year.
A broader increase in commodity bill will underpin annual imports – a mix of crude oil, coal, fertilisers, edible oils purchases, etc. Stepping up crude oil imports from Russia (share rose from <1% earlier in the year to ~10% this month) will improve the terms-of-trade position (on higher exports of processed petroleum) but the share is still small vs overall crude oil purchases. We estimate a 20% yoy increase in overall imports, outpacing export growth. This will likely leave the merchandise trade deficit ~40% wider this year.
In nominal terms, the CAD is expected to widen to $115bn, amounting to -3.2% of GDP. Pulling in the financing end, the annual balance of payments will likely return to a deficit of about -$40bn.
Modest breach of the fiscal deficit target
Gross tax revenues in FY22 not only exceeded revised estimates but was also 0.6% of GDP higher than FY21, benefiting from commodity prices, formalisation as well as inflation, reflected in corporate income and GST collections. On the latter, the monthly average has improved in the past years, while corporate tax collections benefited from the pandemic-triggered acceleration formalisation and wider margins.
Strong revenues coupled with double-digit nominal GDP (19.5% yoy vs budgeted 14.1%) helped absorb additional spending demands and contain the centre’s fiscal deficit at -6.7% vs budgeted -6.9%.
Into FY23, recent developments point to an increase in spending demands, likely narrowing the revenue-side cushion. Budgeted FY23 expenditure faces upside risks from:
While spending demands are rising, there are few offsets: higher nominal GDP assumption (+0.4%) and the likelihood of higher tax revenues/buoyancy (+0.5-0.6%). Netting off the two ends, budgeted math will still require reprioritization in existing spending heads. Additionally, press reports suggest that expenditure might rise by another INR1trn (0.4% of GDP) on higher subsidies, an extension of the free food scheme and the need to offset rising agri input prices. We expect the FY23 target to rise to -6.6% of GDP vs budgeted -6.4%. High government spending supported growth through the pandemic, but this is likely to peak this year.
Notably, the centre’s fiscal deficits have upshifted from -3.5-3.6% of GDP to above -9% at the peak of Covid and have since averaged –6.6-6.7% of GDP, with part of the increase also influenced by the government’s prudent move to absorb part of the off-balance sheet spending on to the books. Pressure to gradually consolidate finances is likely to return to the fore, towards medium-term goalposts towards -4.5%, assuming a manageable pandemic situation. Factoring in state finances, the cumulative FY23 fiscal deficit is likely to stay elevated at -9.5% of GDP.
Watching the evolving situation
Expectations of a sharp rise in global policy/ markets rates and liquidity is expected to moderate global growth. While some commodity groups are displaying signs of peak in recent weeks, any broad-based correction in this space will alleviate pressures from capital flows, currency as well as external math, providing relief to India’s external math as well. We continue to monitor developments closely.
Market implications
Spot USD/INR continues to test the authorities’ resolve, with the central bank maintaining an active hand in keeping volatility and one-way aggressive moves in check. FX reserve stock is marginally below $600bn, due to non-dollar asset valuations as well as interventions to offset steady portfolio outflows but fares well on most coverage ratios. Net FX forwards book is also being run down, likely by another $12-15bn from outstanding $63bn as of end-Apr22 and this strategy is bound to keep currency vols low, besides not adding to spot INR liquidity. Compared to AXJ pairs, the rupee is near the middle of the pack year-to-date, less steep decline than the South Korean Won and Philippine peso. We continue to be in the camp expecting a gradual upside in the USDINR this year, punctuated by official presence to soften the slope.
Borrowing costs already face upward pressure on unfavourable global cues (higher UST yields, high oil etc.) as well as tightening financial conditions at home (policy normalisation and demand-supply mismatch). The gross borrowing program for the year is set at INR14.3trn, with INR8.45trn due to be raised by Sep22 (first half of FY). Auctions have gone largely smoothly yet far, barring sporadic occasions of devolvement, but yields have, nonetheless, risen. While spending demands are up, authorities will be reticent to raise the size of GSec issuances, to prevent further hardening in borrowing costs. Hence, alternatives by way of tapping available cash balances and reprioritisation in existing spending heads to keep within the issuance size will be the main approach, whilst developments on GST compensation demands from states are under watch.
Bonds’ demand-supply imbalance will, nonetheless, necessitate the central bank’s participation during the course of the year (~INR 2.0-2.5trn). This will kick into action once excess liquidity surplus returns to non-inflationary zone. In its April’s Report on Currency and Finance, a study highlighted that a “net LAF surplus of more than 1.52 per cent of NDTL could be inflationary. The results show that a one percentage point exogenous increase in surplus liquidity above this threshold value could push up inflation by 60 bps on an average in a year”. Banking system liquidity has moderated to INR 3trn in June from INR 6trn in late-April, and weighted average overnight rates have sharply risen since the hawkish pivot at the April MPC. Support by way of open market operations is likely from second half of the year.
APPENDIX
To read the full report, click here to Download the PDF.
The information herein is published by DBS Bank Ltd and/or DBS Bank (Hong Kong) Limited (each and/or collectively, the “Company”). This report is intended for “Accredited Investors” and “Institutional Investors” (defined under the Financial Advisers Act and Securities and Futures Act of Singapore, and their subsidiary legislation), as well as “Professional Investors” (defined under the Securities and Futures Ordinance of Hong Kong) only. It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. This research is prepared for general circulation. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies. The information herein is not directed to, or intended for distribution to or use by, any person or entity that is a citizen or resident of or located in any locality, state, country, or other jurisdiction (including but not limited to citizens or residents of the United States of America) where such distribution, publication, availability or use would be contrary to law or regulation. The information is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction (including but not limited to the United States of America) where such an offer or solicitation would be contrary to law or regulation.
This report is distributed in Singapore by DBS Bank Ltd (Company Regn. No. 196800306E) which is Exempt Financial Advisers as defined in the Financial Advisers Act and regulated by the Monetary Authority of Singapore. DBS Bank Ltd may distribute reports produced by its respective foreign entities, affiliates or other foreign research houses pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Singapore recipients should contact DBS Bank Ltd at 65-6878-8888 for matters arising from, or in connection with the report.
DBS Bank Ltd., 12 Marina Boulevard, Marina Bay Financial Centre Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E.
DBS Bank Ltd., Hong Kong Branch, a company incorporated in Singapore with limited liability. 18th Floor, The Center, 99 Queen’s Road Central, Central, Hong Kong SAR.
DBS Bank (Hong Kong) Limited, a company incorporated in Hong Kong with limited liability. 13th Floor One Island East, 18 Westlands Road, Quarry Bay, Hong Kong SAR
Virtual currencies are highly speculative digital "virtual commodities", and are not currencies. It is not a financial product approved by the Taiwan Financial Supervisory Commission, and the safeguards of the existing investor protection regime does not apply. The prices of virtual currencies may fluctuate greatly, and the investment risk is high. Before engaging in such transactions, the investor should carefully assess the risks, and seek its own independent advice.