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India on the up again as current account gap narrows

Fri, 04/07/2023 - 11:07

When talk turns to major developing economies, India can sometimes find itself overlooked. However, with a population of more than one billion and industrial might to rival some of the world's biggest economies, we would all do well not to underestimate the great sub-continent. It's not without reason that some refer to the South Asian nation as the New China. In fact, India's GDP growth rate averaged between 5-10% from 2010-2020 and, last year, it finally overtook China for the title of Asia's largest economy and the world's fastest-growing major economy.

But, like the rest of the world, India had some of the wind taken out of its sails by the pandemic. Supply chains were broken, and industrial output dwindled amid weaker demand for durable goods and energy products worldwide. Things got so bad that the emerging market's current account deficit reached an all-time high of $36.4 billion (or 4.4% of its GDP) in Q3 2022. Now, however, the tide finally appears to be turning, with the latest predictions tipping a reduction of the Indian trade deficit to 2.7% of GDP in Q4 2022. This will, of course, come as good news for the rupee, which has been underperforming of late. But what does it mean for world markets and investors in India and beyond?

Always believe in…gold!

It's a little-known fact, but India is the world's second-largest consumer of gold. In fact, before it was overtaken by China in 2009, it was actually the largest. As such, the performance of the Indian economy has a huge effect on the global precious metals market. While the overarching trend in the West is for gold to rise commensurate with economic strife and uncertainty, India's relationship with the yellow metal is very different. For many on the sub-continent, gold is the preferred method of saving, with many prizing it for its phenomenal store of wealth capabilities. Thus, when the Indian economy is doing well and the country's citizens have surplus income to save, gold tends to experience upticks in demand. 

Indeed, Indian gold consumption in the bear market of 2022 stood at 774 tonnes, which was down from 797 tonnes in the post-pandemic buzz of 2021. Now, the World Gold Council is predicting increased demand on news that El Nino will likely not affect the 2023 monsoon season, which is absolutely crucial to Indian agriculture. With rural India accounting for up to 60% of the country's gold market, the effect of the surplus wealth generated by a good harvest will likely translate not only to higher gold prices in Q3 and Q4 of this year but also to declines in the price of India's major agricultural export, sugar cane.

Crude but effective

Energy is the lifeblood of any economy, and for an energy-producing country, good fortunes are typically measured in exports. However, for the past year or so, the energy markets have been anything but typical. Despite reduced supply and increased demand for oil and gas products on account of geopolitical insecurity on Europe's borders, Indian energy exports have been yo-yo-ing between extremes since at least late 2021.

While the country doesn't export much crude oil at all (since it only has 3 years' worth of extractable reserves available), it is a major exporter of value-added petroleum products. With the abundance of cheap Russian oil, the Asian nation has seen its refined product exports rise exponentially. From April 2022 to January 2023, this indicator increased to $78.6 billion, up 54.78% from $50.8 billion year over year.

While one would think this would be good for the country's trade balance, we also have to consider how much crude it has imported from Russia. From April through December 2022, Indian imports of Urals crude stood at $27.7 billion, a 700% increase from $3.4 billion in 2021. Naturally, there is a lag between when crude is imported and the refined derivatives are exported. Thus, any changes in the Indian current account balance should be taken with a grain of salt for the moment.

Return to favour for risky rupee

As much as Indians love gold, like in any country, the national currency is the most liquid form of money, with its value tied inextricably to the economy's health. As an inherently "risk-on" currency, the rupee suffered severely since as early as 2020 and has now lost 20% of its value against the world's safe-haven currency, the US dollar. India's relatively poor trade balance, coupled with an aggressively hawkish monetary policy from the Fed, threatened to push the rupee even lower, but the tide now appears to have turned. With Barclays and Citigroup slashing their Indian current account gap forecasts to 1.9% and 1.4% of GDP, respectively, it looks as if the RBI will now be able to cut its sales of foreign currency reserves while still holding back imported inflation.

The recent turmoil in the US banking sector that culminated in the collapse of SVB and Signature earlier this month has also forced the US regulator to tone down its hawkish rhetoric, with the FOMC announcing a relatively dovish hike of just 25 bps as it similarly reduced its target rate from 5% to 4.75% in a bid to settle markets. The end result of this fortuitous combination of circumstances for the rupee could see the Indian national currency become naturally stronger on its own fundamentals while the greenback continues to weaken amid ongoing worries of systemic risk to the US banking sector. The gains are unlikely to be huge, but the USD/INR pair could still prove a lucrative long position for active forex swing traders.

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