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Economics:

External sector remains key tailwind

Focal point: Downside to FY24E CAD likely

Merchandise trade deficit in December 2023 has narrowed to its lowest levels since July 2023 as exports rose at a faster pace than imports. Services exports sustained at a healthy pace to keep overall net exports at comfortable levels, thereby providing potential downside to current account deficit estimates for FY24. We see current account deficit of 1.3% of GDP in FY24E. Continued comfort on external sector indicators amid the positive outlook for flows – both debt & equity – and the US Fed’s recent policy pivot should support appreciation of the INR. We expect a USD-INR rate at 81.0-81.5 by March 2025E.

The key risk to monitor is continuity of geopolitical tensions, which if they were to escalate, would become a risk for India’s merchandise trade. If the risks persist, we expect FY24E exports growth to drop by 8.7% vs a 7.2% YoY decline under base case.

Rising exports narrows trade deficit for December:

India’s merchandise trade deficit narrowed to USD 19.8bn in December 2023 vs USD 20.6bn in November 2023 as sequentially exports grew at double the pace of imports. On a YoY basis, merchandise exports increased by ~0.9% YoY to ~USD 38.4bn in December vs ~2.8% YoY decline in November. Imports rose to USD 58.25bn but was down 4.8% YoY in December vs a 4.3% YoY decline in November. Core imports rose USD 3.3bn to ~USD 37.9bn in December, the highest levels since August 2023.

In this fiscal, merchandise trade deficit touched ~USD 188.0bn to date, vs ~USD 212.3bn during the same period last year. Services trade surplus is at ~USD 118.7bn vs ~USD 104.2bn during April-December FY23.

CAD at 1.3% in FY24E; impact minimal from the Red Sea crisis

We see FY24E CAD at 1.3% from earlier 1.5%. Key risk to our call is expected to come from supply chain dislocation due to geopolitical crisis, which could jolt merchandise exports. Our Elara Supply Chain Pressure Index rose 33.2% in January 2024 to date vs ~21% rise in full December 2023 on sequentially MoM basis. However, recent moderation in the Baltic Dry Index indicates that with demand staying muted, sustained supply-side crisis is unlikely as during CY21-22.

Under a moderate risk scenario, FY24E exports can drop by ~USD 7bn with exports to Europe (~23% share in India’s merchandise exports in FY23) declining by 3.5% YoY. However, provided services trade balance remains steady or moderate slightly; we expect the impact of Red Sea crisis to be minimal, pushing FY24E CAD higher by 20bp.

External ratios remain comfortable; flows continue to come in:

India’s imports coverage ratio stands at 10.7x (9.4x long-term average until February 2020). External short-term debt coverage has been on an increasing trend and stands at ~4.8x vs 4.0x (average of January 2010 to February 2020). Net FII flows have started on a strong note with the first half of January 2024 witnessing net inflows of ~USD 1.7bn (equity + debt) after ~USD 10.1bn in December 2023.