Economy less vulnerable but not immune to pre-FOMC jitters: DBS Group Research

Ahead of the US Federal Reserve's rate decision due this week, markets are likely to be on tenterhooks. While there is uncertainty over how the markets will react to a lift-off (or not) in the Fed Funds Rate, India's improved external balances and higher reserves will hold the economy in good stead. But external debt continues to climb, which suggests that the economy is less vulnerable to FOMC-led jitters, but not immune.

Aug trade numbers out yesterday saw the deficit stay wide at USD 12.4bn as exports plunged 21%, marking nine successive months of contraction. Imports fell by a smaller 10%, as part of the 42% decline in the oil imports bill was offset by a 7% rise non-oil imports. Gold purchases in particular jumped 140% as sharp fall in global prices likely stoked demand for this segment.

On this count, yesterday's cabinet approval of the proposed gold monetization plans and sovereign bond sales should help rein in gold imports in the coming months. For the time being, despite the recent modest widening in the trade deficit, we don't expect the full-year current account to get out of hand. In fact, the slightly wider current account deficit in Apr-Jun15 attracted little attention.

Jun quarter C/A deficit widened to -1.2% of GDP from -0.3% in Jan-Mar, but is down from -2% of GDP in the comparable period year before. The fourquarter trailing average has seen the deficit shrink to -1.3% of GDP from a peak of -5% in early 2013.

Lower crude prices have helped narrow the monthly oil import bill by close to a third in the first five months of FY15/16. While the latter helped to rein in the trade deficit, part of the impact was negated by a simultaneous decline in exports. With services trade also feeling the heat of late, we expect the current account gap to widen modestly to -1.6% of GDP in FY15/16 from -1.3% last year. However, with funding risks well in control, low commodity prices and current account gap well within the comfort zone, India is well-placed amongst its peers.

In addition, contrary to expectations India actually attracted capital inflows (see chart) during the last two US rate hike cycles. With the economy's fundamentals in a much better shape this time around and higher foreign reserves buffer, India's vulnerability to external developments has eased considerably. But there are a few soft-spots. In the run-up to the US FOMC, a strong dollar and/ or a bout of weak foreign sentiment will hit economies with current account deficits, low foreign reserves. In this account, India is well-placed on first two points but needs work on the third (DBS; Facing ECB QE and a strong collar; 30Jan15).

Despite the recent climb, reserves fall short of overall external debt. But the current stock of over USD 350bn is ample to meet short-term debt and covers 8x months of imports. Moreover, India's net international investment position, also referred to as the 'net wealth' of the economy has deteriorated in the last decade (DBS; Triangulating Asian Angst: the US, China and the 97 question; 7Sep15). Overall, in the event of a risk-off reaction, domestic markets are unlikely to be left unscathed, but intensity of the sell-down is likely to more contained than in the past and against its peers.

Source : Equity Bulls

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