The rupee should depreciate to Rs82 in FY23 as compared to Rs75.8 at the end of FY22 based on the premise that rising trade deficit and steep capital outflows would hurt India’s external sector dynamic. High commodity prices led to 33% YoY growth in imports in FY23YTD while exports are lagging at 12.3% YoY. The resulting trade deficit would cause the current account deficit (CAD) to widen to 3.5% of GDP in FY23 from 1.2% in FY22. Similarly, India’s capital outflows at USD9bn in 1HFY23 had put severe pressure on the INR.
Even at 3.5% of GDP, the CAD would remain within manageable levels in FY23. A major risk could be the escalation of the geo-political crisis causing oil prices to rise from the current USD90-95/bbl to USD105-110/bbl. With respect to capital outflows, we should be past the worst. FII/FPIs have been net buyers of Indian equities since Oct’22 and given India’s relative outperformance amongst EMs, this trend should continue. On the other hand, India’s inflation dynamics are much better than its peers and developed countries. Adjusted for inflation, the interest rate in India remains positive when compared to the US and this should attract capital flows. These two reasons have helped India’s currency outperform most of its EM peers. Despite the rupee depreciating by 8.5% since the start of the current FY, it remains much lower than the 10.8% average depreciation witnessed in 23 major EMs (including India). Given current growth inflation dynamics, we believe USD-INR would be range-bound at 80-82 until the end of FY23. An appreciation of the rupee beyond 80 is unlikely given the widening trade deficit.
India’s economic outlook will also play a major role in determining the value of the rupee. Five key trends would help India in the medium to the long run and these trends will help the Indian economy outperform its EM peers and attract capital flows and therefore pose a low downside to INR hereon.
(1) India’s low external debt: India continues to use capital controls to limit foreign ownership of its debt. On the sovereign front, India’s foreign borrowings are less than 2% of its funding requirements. As a result, India’s external debt to GDP is at 19%, which is lower than all major emerging markets and advanced countries except China. Having a low external debt has helped India remain insulated from currency volatility risks associated with high external debts.
(2) Shift within households’ financial savings: The number of demat account holders have touched 100mn in FY23YTD vs just 40mn by end of FY20, which reflects a structural change in India’s household financial saving pattern. The flow of financial savings to equities and mutual funds have risen from 0.4% of GDP in FY20 to 1% of GDP in FY22. This could rise to 5% of GDP over the next decade.
(3) Corporate debt and profitability: Large corporates are in a financially strong position now. Their debt to GDP is at a 15-year low and they have also retained most of their profits in FY22. With industrial credit growth making up for lost ground in recent months, large corporates could be drivers of capex in the coming years.
(4) Central Government capex: The Centre’s share of capex to overall expenditure has increased from 12% in FY18 to 19% in FY23 (budgeted). It has been focusing on infrastructure through capex in the road and railway sectors. This is a welcome move as capex has a higher multiplier effect on the economy than revex.
(5) Government’s continued focus on DBT: By transferring subsidies directly into the bank accounts of beneficiaries, the government is reducing a lot of leakages in the system. It has been able to save ~Rs2.2trn since its inception in CY14.
(The author, Sumit Shekhar, is Senior Economist, Ambit Capital)
