global financial markets: India’s no longer ‘fragile’, can weather global market volatility

The roiling of global financial markets has always led to worries on the currency front back home given the high current account deficit. This year though, any volatility resulting from global spillovers may not lead to runaway depreciation of the rupee as the narrowing deficit has made the local unit resilient, say economists.

The rise in exports post-pandemic has given India’s current account the necessary buffer, particularly since the outbreak of the Russia-Ukraine war in 2022, notes a report by Barclays Capital. Despite the steep surge in commodities such as crude oil, natural gas, vegetable oil, and fertilisers on which India is heavily import dependent, the current account deficit (CAD)was at a manageable 2% in FY23.

“Reduced current account financing and improved capital flows have added to the economy’s macro stability, a far cry from its categorisation as one of the ‘Fragile Five’ economies a decade ago,” said Rahul Bajoria, head of EM Asia (ex-China) economics research at Barclays Investment Bank.

India’s external vulnerability remains low as import cover – measured as months of imports that forex reserves can fund – remains comfortable at around 11 months compared to seven months in 2012-13. Even foreign exchange reserves as a share of external debt at 99% is the highest over the last 10 years – excluding the pandemic year of 2020 – compared to 71% in 2012-23 before the taper tantrum that escalated in September 2013.

The Reserve Bank of India is also equipped with over $600 billion of reserves to defend the rupee compared to $292 billion in 2012-13, adding to the market perception that the central bank is extra vigilant.

“In our view, the RBI is keeping liquidity conditions tight to protect the economy and the currency from undue volatility given the financial risks brewing globally,” wrote Neelkanth Mishra, chief economist at Axis Bank in his outlook for 2024.

Axis Bank expects the CAD to remain at 1.0-1.5% of GDP in the next two years. “The rupee’s real effective exchange rate has been remarkably stable over the past five years as the RBI has dampened volatility. … this year the rupee has been less volatile against the dollar than even against the yuan,” Mishra wrote.

Goldman Sachs is also forecasting a narrower CAD in 2023 and 2024 on the back of lower oil price forecasts from $86/barrel on average to $84/bbl in 2023 and from above $90/bbl (average) to $81/bbl in 2024, and services exports springing a surprise compared to earlier expectations.

India Ratings expects CAD at 1.3% of GDP in FY24 from 2.0% in FY23. Flows in the capital account are estimated to improve to $73.8 billion in FY24 from $58.9 billion in FY23. This would lead to a net addition of $29.8 billion to the forex reserves in FY24. Ind-Ra expects this to help the rupee average to 83.05 a dollar in FY24.

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