Indian Economic Update
External sector outlook continues to remain favourable
- Current Account Deficit (CAD) reduced in FY 2017 to 0.7% of the GDP on account of lower trade deficit. Exports posted a moderate growth while imports contracted during the period.
- Capital flows were favourable amid strong FDI inflows. Continuation of strong FDI flows reflect the favourable outlook for growth prospects going forward.
- We expect CAD as % of GDP to remain comfortably low. Pickup in gold and non-crude non- gold imports, protectionist measures by advanced economies, volatility in the capital flows and softness in remittance related inflows are the key risk factors to monitor.
Other key developments during the week were:
- Rating agency Fitch sees India GDP growth rising to 7.4% FY 2018 and 7.5% in FY 2019. The agency also expects the RBI repo rate to remain unchanged till end 2018, and rising by ~50 bps in 2019.
- The RBI released the minutes of the June policy meet. The minutes revealed that RBI Governor, Mr. Urjit Patel and the other MPC members argued for avoiding premature policy action citing ‘"high uncertainty’" on inflation outlook while voting for status quo on interest rates at the monetary policy review earlier this month. Dr. Dholakia was the sole dissident in the six member MPC and was in favour of a 50 basis point cut in the repo rate.
Key developments during the week:
- Federal Reserve Bank of New York President, Mr. William Dudley (voter + dove) has said that he expects that a tight labour market will raise wages and eventually trigger a rebound in inflation data.
- BOE governor, Mr. Mark Carney highlighted the risks to consumer spending, business investment, the current-account deficit and financial services. He indicated that he is in no rush to raise interest rates, saying he wants to see how the economy responds to the ‘“reality of Brexit negotiations’”. The pound subsequently weakened following Carney’s comments.
- Minutes of the Bank of Japan (BOoJ) policy meeting of April 26 revealed that policymakers expect the inflation expectations to remain weak. A few members see CPI not reaching 2% during the projection period. One member said JGB purchases cannot be maintained next year unless the bank starts reducing its purchases now.
- US Senate introduced its version of the American Healthcare bill which is likely to go to vote next week.
Indian equities started this week higher tracking positive cues from Asian peers. The rally in global equity markets was led by gains in the technology sector which are in a recovery mode post last week’s slump. Finance Minister, Mr. Arun Jaitley’s assurance on roll out of GST by July 1st coupled with his optimism on its benefits to revenue and GDP growth has boosted the market sentiment.
Meanwhile, risk averse sentiment prevailed globally after the slump in oil prices. Further, MSCI’s decision to include some Chinese shares in their index led to capital outflows from many Asian equities into Chinese markets. State governments announcing farm waivers have weighed on bank shares.
A rebound in the stocks of metal and energy companies along with pharmaceutical companies aided indices. Benchmark indices scaled fresh lifetime highs, with Sensex reaching a high of 31,522 on the back of release of RBI’s MPC minutes.
During the week Sensex gained 0.26% to close at 31138.21 while Nifty declined 0.14% to close at 9574.95.
Indian Government bonds started this week marginally higher. Bonds traded in a narrow range in the absence of fresh cues. Traders also remained on the side-lines ahead of the release of MPC’s during the beginning of the week. The overall sentiment continued to remain benign as investors were hopeful of an imminent rate cut by the RBI during the next policy meeting. The fall in crude oil prices also provided some tailwinds for the Indian bonds. Gilt ended marginally lower towards the end of the week. The decline was on the back of profit booking by investors post release of MPC’s minutes of the June policy meet.
Debt market outlook:
• June MPC minutes reinforce expectation of a 25 bps rate cut in August policy amid sharp moderation in inflation. Further monetary easing will be data dependent and we believe that there exists room for the same.
• Debt market outlook has improved and we are constructive on the Indian Central Government securities. The debt market is favourably supported by the rate cut consideration and benign fiscal roadmap at the Centre. However, India’s evolving India’s state finances amidst the recent spate of farm loan waivers announced pose a medium term risks to rates.
The 10Y benchmark yield ended at 6.46% as compared to previous week’s close of 6.49%.
Oil started week in red, the fall comes primarily because of Saudi’s Energy Minister, Mr. Khalid al-Falih acknowledging that the oil market still needed some time to rebalance. He added that US production was indeed putting pressure on the prices.
Oil prices have declined substantially, Brent and WTI were trading at USD 46/ barrel (-1.75%) and USD 43 / barrel (-1.72%) respectively on Tuesday amid expectations that the Trump administration would come up with a report favouring fossil fuels, an industry report was published, which pitched for renewable sources, leading to slight fears that oil demand might reduce in the future.
Oil prices gained, the rise came on the back of release of EIA’s official data which showed a draw in US oil inventories.
Gold started this week on a lower note hitting a four-week low amidst a firming up of USD. Prices were, however, supported by the start of talks on Britain’s departure from European Union.
New York Fed President’s affirmative comments on the possibility of a rate hike by Fed later in the year led to a stronger USD, which resulted in spot gold touching a five-week low. However, this negative weight on gold was curtailed because of uncertainties surrounding Brexit negotiations that had started in Brussels.
Flattening of US Treasury curve was the main factor driving gold prices. Investment demand for gold (indicated by SPDR holdings) rose by 6.2 metric tonnes in June, as compared to a 5.9 metric tonnes decline seen in the month of May.
Rupee to remain supported on robust flows
The rupee continues to trade ranged and is fairly supported on continuing capital inflows. The recent more than expected hawkish rhetoric of the Federal Reserve did not lend any support to the dollar index.
• On the domestic front, although FY 2017 current account deficit remained under control at 0.7% of GDP but FY 2018 has already seen some red flags from the perspective of monthly trade data prints.
• Although oil prices are very low but non-oil non- gold imports especially in items such as electronics has risen sharply and is a cause for concern.
• We acknowledge that “‘one swallow does not a summer make’” hence we will watch for trend confirmation of this sudden rise in trade deficit for the first two months of FY 2018. Overall, we maintain our current account deficit to GDP expectation at ~1.2% of GDP and expect a balance of payments surplus of ~USD 32 bn.
• Over the medium term we retain our view of a mild depreciation of the rupee to 65.5 by March 2018 with a variation of 2% around this level. This is primarily conditioned on the expectation of Fed policies and a slight worsening of the external balance.
Source: ICICI Bank Research, Bloomberg and CRISIL.