Record high trade deficits will be the norm now and the rupee is likely to fall to 82 against the dollar in the third quarter of 2022, analysts at Nomura have said.
The analysts foresee the current account deficit (CAD) widening further to 3.3 percent of gross domestic product (GDP) in FY23, considerably up from 1.2 percent in FY22, due to various factors such as the recent taxation policy on crude oil production.
“The merchandise trade deficit widened to yet another record high of USD25.6 billion in June, driven by lacklustre exports and soaring imports,” said the report.
The earlier record in the trade deficit was reached this May at $24.3 billion. On a seasonally adjusted basis, the trade deficit widened to $29.9bn from $25.8bn in May.
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Export growth moderated in June to 16.8 percent year-on-year (YoY) growth from May’s 20.6percent, while import growth remained elevated at 51 percent YoY in June against May’s 62.8 percent.
Rupee’s fall
Widening CAD is going to remain a drag for the rupee, which will be worsened by the FPI outflows–$28.9 billion year-to-date net foreign outflows–and the currency will fall to 82 against the US dollar in the third quarter of 2022 and then rise to 81 in the fourth quarter. There will only be “limited offset” from India’s FDI and OI inflows, the analysts noted.
The Federal Reserve’s aggressive tightening, which will lead to a stronger dollar, can cause a recession in the US by the fourth quarter of 2022, according to Nomura.
The analysts wrote, “Such an environment is not conducive for EM/Asia FX that are dependent on healthy global growth and equity-related inflows, including INR.”
“We are also somewhat concerned about the RBI’s apparently ambivalent commitment to its 4 percent inflation target, which could further discourage FPI into the local bond market (year-to-date net foreign outflows of $2 bn),” they added.
What could slow down the rupee depreciation is RBI’s dollar selling intervention, the analysts said.
CAD to worsen
They gave five reasons why the CAD will widen to 3.3 percent in FY23. In the second half of this calendar year, they expect CAD to widen to 3.6 percent of the GDP from 2.7 percent of GDP in the first half.
“First, the latest measures by the government—windfall taxes on crude oil production, export restrictions on petroleum products and an increase in gold import duties—are unlikely to improve the current account. Gold import demand is less sensitive to higher taxes, while the export taxes could moderate oil exports,” it said.
Second, the delayed reopening in India means a robust domestic demand for relatively price-inelastic commodities such as crude oil, vegetable oil, gold and chemicals. This would mean a higher import bill.
Export growth in the coming months is likely to weaken on deterioration in global growth, the report said. It said, “We believe the export downturn has already started and will accelerate in H2 2022”.
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The recent correction in commodity prices will help but the benefits will materialise only with lags, wrote the analysts. “Moreover, oil prices remain elevated, and with domestic fuel prices unchanged since the third week of May, underlying fuel import volume growth should remain high,” it said, giving out the fourth reason.
Finally, while “import value growth is likely to rise over the near term, any improvement in the current account due to weak currency effects will likely only materialise over the medium term”, it said.
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