India: Counting on terms of trade relief
- 4Q22 (3QFY) GDP is set to moderate as base effects overshadow sequential rise
- Commodity prices, especially oil, are off war-induced highs
- This carries some terms of trade relief
- We expect monetary and fiscal policy to play a complementary role
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4Q22 (3QFY) GDP growth in the pipeline
India’s 4Q22 (3QFY23) GDP growth data is likely to point to further strengthening in the growth momentum. Our mix of high-frequency data points to a sequential improvement in the quarter, even as YoY growth is set to moderate on base effects.
Investment and production engines likely improved whilst consumption normalised, keeping recovery uneven. Lead indicators for urban demand are mixed as passenger vehicle sales grew, besides double-digit increase in personal loans, better air passenger growth, and firm employment numbers. This was countered by signs of dissipating boost from reopening and pent-up demand which had helped in 1Q-3Q22, amidst visible signs of destocking, deceleration in consumer durables output and reduction in household savings. Rural fam indicators have bottomed out, with rabi sowing acreage up 3% vs last year and 13.7% vs 5Y average. Rural wage growth is improving but is still soft on real terms. Falling demand for MNREGA and better returns on foodgrains are positives yet worries over inclement weather is likely to persist as the harvesting period in Mar/ Apr approaches.
Most investment/ production related indicators, meanwhile, held ground including PMIs, >70% capacity utilisation rate and better steel/cement production, besides higher public sector capex spends. Impact of tighter financial conditions is still to materially impact industrial credit demand, as latter also benefited from substitution effects. Lastly, net exports likely weakened as goods exports rose 7.4% yoy vs 16.5% rise in imports, leading to a wider trade deficit in the period. Into 2023, we expect the terms of trade relief from lower commodity prices to underpin goods trade balances.
Service sector activity continued to improve, backed by better rail freight and cargo traffic, non-food bank credit growth, aggregate deposit growth and government revenue expenditure minus interest payments, which rose 13% yoy in Oct-Dec22 vs a decline in the quarter before.
Building in high frequency prints and our proprietary GDP Nowcast model, we expect 4Q22 (3QFY23) real GDP growth to rise 4.8% yoy from 6.3% in 3Q22, with GVA at 4.6%, This lends modest upside risk to our annual FY23 growth pace (DBSf: 7%).
Terms of trade relief
Geopolitical tensions and resultant supply worries had injected a fear premium in most commodity groups last year, sending prices sharply higher. Key indices are since off highs. Even as certain segments have bounced on China’s reopening boost, levels are unlikely to return to war-induced levels witnessed in 1H22. For instance, the Bloomberg commodities and CRB spot metal indices are down ~14-15% from May22 high. Separately, benchmark Brent is down by ~30% from mid-22, with the UN Food and Agriculture index also registering a double digit fall from 1Q22 high, Terms of trade relief from lower oil in particular, is likely to be apparent on three fronts:
- Current account worries to abate
Merchandise trade deficit is likely to narrow in FY24, providing relief on current account balances.
Firstly, the average Indian crude oil basket price has fallen by ~20% between Dec22-Mar23 compared to Apr-Nov22. Factoring in our in-house expectations of $85-90pb for 2023 vs $96/pb average FY23 YTD, the oil import bill is likely to moderate by a quarter to $160bn vs forecasted $214bn for FY23.
Additionally, discounted oil imports from Russia rose to a record high in Jan23, making a quarter of total purchases in Dec22 vs less than 5% in 2021. This has led Russia to emerge as the second largest oil supplier to India in this FY yet far, followed by Saudi Arabia. This has not only contributed to a lower import bill on fuels, but also lifted exports of refined petroleum shipments to Europe, Asia, and the Middle East.
Next, the improving export mix – towards electronics, machinery and engineering goods and pharma have led India’s exports to retain some extent of resilience. With key trading markets expected to skirt recessionary conditions as well as relative rupee competitiveness, we expect the deterioration in external imbalances to narrow. The central bank’s presence has helped to successfully limit rupee volatility and address the currency’s valuation concerns as the INR real effective exchange rate corrects (below 100 as of Jan23) – see chart.
These, we expect, will abate current account concerns next year, as we expect the deficit to narrow from -3.0% of GDP in FY23 to -2.6% of GDP. More concerns will surround health of capital flows as direct investment flows have slowed, portfolio outflows from equity ($3.8bn in Jan-Feb23) overshadow modest inflows into debt ($0.7bn) and incremental non-resident inflows moderate.
- Resource-based imported price pressures moderate
Domestic fuel prices have remained steady since middle of 2022 despite a correction in international benchmark prices, as local taxes add downward rigidity to costs. Base effects will, nonetheless, show year-on-year degrowth over the next 4-6 months. Concurrently, lower tradable pressure is also visible in the moderating wholesale price index inflation which is down to a two-year low in Jan23. The WPI index tracks the Bloomberg Commodities closely, as shown in the chart below.
The latest December 2022 edition of the Business Inflation Expectations Survey by IIM Ahmedabad highlights moderating input costs pressures. The percentage of firms perceiving cost increases of over 6% and 10% continue to decline in recent rounds, with the distribution of responses stabilising around 3-6% mark.
While imported forces ease, domestic inflation is stirring back to life yet again for other reasons. Headline inflation has been sticky in the elevated 5.7-7.0% range in the past year, in breach of the target 2-6% range, with the core (ex food and fuel) caught in a high but narrow 5.8-6.2% band.
Drivers continue to vary, with the latest bout boiling down to firm cereal costs and non-perishable protein sources, even as the usually volatile vegetable component relented. Additionally, goods appear to be contributing to the headline more than services, likely reflecting better demand from rural counterparts as well as manufacturers continuing to adjust prices and restore margins. The latter is captured by the wide gap between falling WPI indices, whilst CPI inflation hold ground.
Overall, elevated Jan inflation outturn, sticky core, and a likelihood that Feb23 inflation, which will be out in mid-Mar might also stay above 6%, raising the odds of a follow-up rate increase at the April rate review. We expect an additional 25bp hike in April to take the rate to 6.75%, before drawing a pause.
- Relief via subsidies has been channelled into higher capex spend
Fiscal consolidation presented in the FY24 Union Budget (India FY24 Budget: Growth support; fiscal consolidation) primarily rests on the normalisation in revenue expenditure, on lower food and fertiliser subsidies (latter assumes commodity prices). The central government targets to shrink the subsidy bill to INR 4trn in FY24 vs revised INR5.6trn last year.
For the time being, we expect monetary and fiscal policies to play a complementary role. By affirming the FY26 fiscal deficit target at -4.5% of GDP, the central government has set itself on the path of rationalisation in finances over the next 2-3 years, whilst balancing this with the need to prioritise growth-supportive capital expenditure. On monetary policy, minutes from the Feb RBI monetary policy committee (MPC) review reflected concern over inflation, owing to uncertain geopolitics, volatile crude prices, and weather-related events. Outside of food, inflation was seen at the risk of hardening further, requiring policymakers to take calibrated action. Thereby a majority of the MPC is likely to vote for a 25bp hike in April with an unchanged stance.
Relief from commodity prices assumes absence of fresh geopolitical troubles or sharp upside surprises on global growth which could stoke prices and complicate India’s macro balance. While China’s reopening theme has marked a floor for certain commodity groups, we are not of the view that a broad-based rally like 2022 is on the cards, which in our view was driven more by fear/ risk premia rather than structural demand-supply dynamics.
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