Close monitoring of trade deficit, portfolio outflows warranted: RBI article

Amid a hostile international environment, close and continuous monitoring of the widening trade deficit and portfolio outflows was warranted, strong reserve buffers notwithstanding, a team of authors led by RBI Deputy Governor M.D. Patra said in an RBI article.

They, however, took comfort from the fact that recent moderation in commodity prices and easing of supply chain pressures would help the nation in escaping the global inflation trap.

The Indian economy remained resilient in the face of formidable global headwinds, they said, but added “knock-on effects of geopolitical spillovers are visible in several sectors, tapering the pace of recovery.”

The international environment “is hostile and hence, close and continuous monitoring of the widening trade deficit and portfolio outflows is warranted, notwithstanding strong reserve buffers, moderating external debt and a fairly valued exchange rate that has wilted less in the face of the monotonic strengthening of the U.S. dollar than many peers”, they pointed out in the article on the state of the economy published in the RBI Bulletin for July.

The central bank said the views expressed in the article were those of the authors and do not necessarily represent the views of the Reserve Bank of India.

“In spite of this overwhelming shock, there are sparks in the wind that ignite the innate strength of the economy and set it on course to becoming the fastest-growing economy in the world, though besieged it might be by fears of recession,” they said.

In support of the argument, the authors said the recent revival of the southwest monsoon and rejuvenation of sowing activity had raised hopes of another bountiful year for agricultural activity, raising expectations that rural demand would soon catch up with urban spending and consolidate the recovery.

“The biggest source of relief is from inflation coming off its recent peak, albeit at an elevated level still. Nonetheless, the signs of its generalisation and the potential unhinging of inflation expectations have elicited a pre-emptive and frontloaded monetary policy response,” they said.

The authors added that amid all these developments, India’s financial sector remained sound and stable.

If the commodity price moderation witnessed in recent weeks endures alongside the easing of supply chain pressures, the worst of the recent surge in inflation would be left behind, enabling the Indian economy to escape the global inflation trap and enjoy the fruits of the ebullient supply response that was taking place, they said.

India’s merchandise trade deficit widened to its highest monthly level of $25.6 billion in June 2022 as against a deficit of $9.6 billion a year earlier and $24.3 billion in May 2022. On a quarterly basis too, April-June 2022 recorded the highest-ever trade deficit of $70.3 billion.

In the foreign exchange market, the Indian rupee depreciated 1% vis-à-vis the U.S. dollar in June compared with the previous month, on the back of FPI equity outflows and a strong dollar.

This was also mirrored in the movement of the 40-currency real effective exchange rate (REER) which depreciated by 0.6% in June 2022 over its level a month earlier.

Foreign portfolio investors (FPIs) were net sellers in the Indian equity markets for the ninth consecutive month in June, with an outflow of ₹49,469 crore (highest monthly outflow since March 2020) and the sell-off continued in July (up to July 8, 2022) to the tune of ₹3,716 crore.

Overall, FPIs have withdrawn ₹1.2 lakh crore from the Indian equity market in 2022-23 so far, but the sell-off has been absorbed by domestic institutional investors (DIIs).

The authors noted that India was set to become the most populous country in the world by 2023. According to the fifth round of the National Family Health Survey, 2019-21, released by the Ministry of Health and Family Welfare (MOHFW) in May 2022, however, India’s fertility rate – the number of children a woman bears in her child-bearing lifetime – has fallen below 2.1, the rate at which the population can replace itself.

Also, COVID-19 infections have been rising in India with new mutations of the virus. High-frequency indicators of economic activity are mixed. Green shoots of revival in contact-intensive services are breaking through.

Among other economic indicators, the authors said, during April-May 2022, gross inward foreign direct investment (FDI) marginally decreased to $16.4 billion and repatriation of FDI increased to $5 billion from their levels a year earlier.

Manufacturing, retail and wholesale trade, computer services, communication services and financial services received most of the investment and accounted for 76.7% of fresh equity flows.