Indian Economic Update
BoP continues to remain in surplus
Current account deficit widens in Q1
India’s Current Account Deficit (CAD) widened to 2.4% of the GDP in Q1 from 0.1% of the GDP in same quarter previous year and 0.6% of the GDP in Q4 FY 2017. The wider CAD was primarily on account of higher trade deficit brought about by a larger increase in merchandise imports as compared to exports. The trend in exports is to be watched over the next few months as the industry adjust to the GST related uncertainty. Meanwhile, any improvement in global demand is likely to support external sector performance going forward.
Invisibles receipt in Q1 were slightly higher at USD 26.8 bn in Q1. Both services and transfers were marginally higher than the previous quarter reading. The stabilisation of private transfer receipts, which mainly represent overseas remittances, is encouraging. The sharp fall in crude prices over the last few years had raised concerns regarding lower remittances from the region.
Capital flows remain robust during Q1
Overall capital flow has been stronger as compared to the previous quarters. Foreign investments were stronger at USD 19.7 bn in Q1 as compared to USD 15.8 bn in the previous quarter. While both FDI and FPI were robust, the latter was particularly strong at USD 12.4 bn. Strong interest in the debt segment and ample liquidity globally have supported the FII related flows during the quarter.
Going forward, given the strong IPO pipeline over the next few months, we expect continued support from the FPI in the equities segment. In other categories, banking capital saw an inflow of USD 6.2 bn led by NRI deposit related inflows of USD 1.2 bn.
BoP surplus supported by robust foreign flows
Robust foreign investment supported the Balance of Payment (BoP) into the positive territory. Overall BoP surplus was USD 11.4 bn in Q1 as against a surplus of USD 7.3 bn in Q4FY2017.
External sector outlook to worsen on the margin
We expect the FY2018 CAD to worsen on the margin to 1.7% of the GDP, though will be easily financed through robust capital flows. The key risk to the outlook is volatility in portfolio related flows amid shift in stance of the global central banks. Overall, we believe that the best of the BoP surplus is behind us and we might see some moderation going forward.
Meanwhile the basic balance, which sums FDI and current account balance, is expected to turn negative after three consecutive years of surplus. Against this backdrop, we expect the Rupee to trade around 64.50 for the current fiscal year with a variation of +/- 2%.
Other important developments during the week:
Media reports have suggested that Indian government is mulling over INR 400 bn stimulus to the economy. FM Arun Jaitley suggested that the government will announce steps to revive economy ‘very soon’.
US Fed policy: Fed remains on track; tapering will start in October
- In line with our expectations, the Federal Reserve announced that balance sheet tapering will start in October as detailed in June 2017 statement.
- The median Federal Funds Rate (FFR) is unchanged for 2017 and 2018 but is down to 2.75 in 2019 from 3.0 in June. The dot plot showed that members have cut down their expected future rate hikes.
- Although the Fed continued to maintain its stance that there will be one more rate hike this year, it acknowledged the drop in inflation as it revised core Personal Consumption Expenditures (PCE) downwards for 2017 and 2018.
- The Federal Reserve shrugged off storm related disruptions and said that they are unlikely to impact the economy over the medium term.
Fed remains on track to raise rates in December 2017
The Fed maintained its stance that it will raise rates further in December 2017. It acknowledged that the inflation running below 2% for a longer time is a cause of concern and the monetary policy stance will change accordingly to reach Fed’s target of 2%. The FOMC stuck to its hiking trajectory in 2018 while sounding dovish on rate hike prospects 2019 onwards.
Other important development during the week:
- The Russian central bank (CBR) cut its key policy rate by 50 basis point to 8.5% on last Friday. The decline in inflation, which stood at 3.3%, below the target of 4%, and the need to support growth were cited as reasons for the cut.
- US President Mr. Trump threatened to annihilate North Korea if it continues to pose a threat to the US. The President struck an aggressive tone in his first UN address.
- The Bank of Japan kept its monetary policy steady and maintained its upbeat view of the economy, signalling its conviction that a solid recovery will gradually accelerate inflation towards its 2% target without additional stimulus. However, the 8-1 split vote had a member dissenting, stressing on the fact that the current monetary policy was insufficient to push inflation up to 2 percent during fiscal 2019.
- Standard and Poor’s has cut its long-term rating for Hong Kong, following its cut to China’s sovereign credit rating on Wednesday, to reflect “spill over risks” to the territory.
- A North Korean official has suggested that the regime may detonate an H-bomb in the Pacific Ocean.
Indian equities started the week higher following positive cues from global equity markets. Strong demand from domestic mutual funds led the Nifty to close at new record highs. Automobile sector saw strong demand in expectation of higher sales during the upcoming festive season.
Domestic benchmark indices ended almost unchanged after investors turned cautious and booked some profits ahead of the two-day US FOMC meet during the week. Telecommunication stocks came under pressure after telecom regulator TRAI slashed mobile call connection charges.
The balance sheet normalisation announced by the US Fed weighed on global equity markets. On the domestic front, reports of Government mulling over measures to give a boost to the economy through fiscal stimulus was received positively by markets.
During the week Sensex lost 1.09% to close at 31922.44 while Nifty declined 1.21% to close at 9964.40.
Indian Government bonds started the week lower. Gilt prices were down as appetite for bonds took a hit after RBI announced an Open Market Operations (OMO) sale of INR 100 bn on Friday. Further, the increase in US Treasury yields over the past week also weighed on domestic gilts.
Gilts traded in a thin band during mid-week as market players remained on the sidelines ahead of outcome of US Federal Open Market Committee's 2-day meet. However, value buying, after the slump in prices supported domestic gilts.
Meanwhile, the 10Y benchmark closed at a four-month high as reports emerged that the Government is likely to resort to fiscal stimulus sparking fears of extra borrowing by the Centre in the current financial year. Further, the US Fed’s decision to go ahead with tapering of its balance sheet coupled with re-iterating the scope for another rate hike later this year also weighed on domestic gilts.
The 10Y benchmark yield ended at 6.68% as against previous week’s close of 6.60%.
Crude started this week in green, trading at a three month high buoyed by reduction in US drilling activity, signaling signs of abating crude surplus. The Baker Hughes data reported a drop in oil rig count by 7 to total 749 for the last week. The decline in rig activity also comes as the lean season for crude demand sets in. Fresh news of key Middle Eastern producers continuing to cut supply buoyed the markets.
Crude is set for its largest third quarter gain in 13 years, buoyed by Iraqi oil Minister’s consensus to extend the supply cut agreement. Ministers from the OPEC and non-OPEC countries meet in Vienna on Friday, September 22, 2017 and are due to consider extending output cuts that began in January.
Gold fell by USD 5/Oz on Monday to trade at its lowest levels this month. The yellow metal hovered around its 2-week low on the back of a rising Dollar and prospects of a tighter stance ahead of the two day FOMC meeting. Gold prices see some selling pressures as investors dismiss geopolitical risks and turn towards the US central bank’s monetary policy. Meanwhile, yellow metal pulled up as the Dollar eased ahead of the FOMC meet.
The yellow metal was supported by a weakened Dollar ahead of the Fed policy statement, while President Mr. Trump’s aggressive comments overnight on completely destroying North Korea, aided the metal’s rally. However, gold was down after the Fed stepped towards a tighter monetary stance.
India Rupee started the week weaker. Heavy Dollar purchases by oil importers weighed on the domestic currency. However, Dollar sales by Public Sector Banks capped the depreciation. INR depreciated sharply, touching its weakest level in 8 weeks, as heavy Dollar demand by foreign banks and importers weighed on the domestic currency.
Meanwhile, gained on Dollar sales for exporters and FPI subscription to ongoing IPOs during the week.
INR ended significantly weaker towards the end of the week. On the global front, concerns over the rating downgrade for China by S&P weighed on the Rupee. The Fed’s guidance of one more rate hike this year also weighed on the domestic currency.
Source: ICICI Bank Research, Bloomberg and CRISIL