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Current account deficit (CAD) could widen to 5.5% of GDP in 2QFY23

* The continuation of hostilities between Russia and Ukraine has led to an entrenched episode of higher inflation across the globe. However, commodity prices have come off sharply from their peaks with renewed concerns on global growth, led by strong monetary tightening that is likely to continue at least until Dec’22. At this juncture, India seems isolated from the high inflation-slow growth challenges. Nevertheless, this isolation will fade over the next few months. We believe that growth concerns will emerge everywhere, including India, in CY23/FY24E, limiting rate hikes and reversing the current narrative.

* Although we have raised India’s FY23E real GDP growth to 6.8%, we have kept our FY24 projection broadly unchanged at just 5.5%, much lower than the consensus of 6.3%. A serious global recession presents a downside risk to our belowconsensus growth forecast.

* At the same time, we have cut our FY23 CPI inflation forecast to 6.7% (from 7.0% earlier), keeping FY24E unchanged at 5.2%. Nevertheless, with the repo rate already at 5.4%, we have raised our terminal repo rate forecast to 6.0% (from 5.5%) by Dec’22. If, however, the RBI remains concerned about the Rupee and focuses more on the 4% target (unlikely to be reached before FY25), we could see another hike in Feb’23E, taking the repo rate to 6.25% in this cycle.

* India’s external situation has also worsened quickly. We expect CAD to widen to 3.7% of GDP in 1QFY23 and peak at 5.5% of GDP in 2QFY23, implying a decadal-high CAD at 3.8% of GDP in FY23. Our estimates suggest that India’s foreign exchange reserves could fall to ~USD530b this year. Accordingly, we believe that the Indian Rupee (INR) could cross 82/USD in 4QFY23E and stay above 80/USD in CY23/FY24E.

Changes in economic forecasts since Jun’22

Real GDP growth: With 13.5% YoY real GDP growth in 1QFY23, the market consensus has been downgraded to sub-7%. However, we have upgraded our FY23E growth to 6.8% from 6.3%, with a broadly unchanged projection of 5.5% in FY24.

CPI inflation and interest rates: After raising it substantially in the past few months, FY23 inflation projection is lowered to 6.7% from 7% earlier, with no change in FY24E. However, the terminal repo rate would be higher than our previous forecast – expected at 6% by Dec’22 (Exhibit 1).

External trade and INR: India’s CAD could worsen to 5.5% of GDP in 2QFY23 and rise towards 3.8% of GDP in FY23E, before easing to ~2% next year. Consequently, India’s foreign exchange reserves could fall to ~USD530b this year, leading to faster depreciation in INR against USD. We expect INR to surpass 82/USD in 4QFY23, and stay above 80/USD in CY23/FY24

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