Jan 15 / Alef Dias

Macroeconomics Weekly Report - 2024 01 15

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Recent data supports the Indian Rupee

  • In 2023, the Indian Rupee recorded an unfavorable performance, mainly due to a historically low interest rate differential against the US.
  • Despite this, the Indian economy has shown a remarkable expansion trajectory, fueling optimistic long-term prospects.
  • In addition, recent data also suggests a more positive outlook for the Indian currency in the short term. Indian inflation accelerated to 5.7% p.a. from 5.6% in November, which should lead the RBI to start its interest rate cut cycle later than the Fed.
  • The reduction in trade deficits should also strengthen the Rupee in the short term. India's trade deficit narrowed for the second month in December, after reaching a record high in October.

Introduction

The Indian Rupee had a negative performance in 2023, largely due to a historically low interest rate differential against the US. However, the Indian economy has shown a robust growth trend, which gives rise to long-term optimism, and recent data also points to greater support for the Indian currency in the short term.

Image 1: Indian Rupee and DXY

Source: Refinitiv

Accelerating inflation is far from worrying and should strengthen the interest rate differential in the short term

Indian inflation accelerated to 5.7% p.a. from 5.6% in November. The increase was due to higher food inflation, especially vegetables. A lower base compared to the previous year and a shortage of onions and tomatoes due to unseasonal rains increased vegetable inflation. These gains are likely to be reversed in January amid increased supply.

There was a general drop in the components of core inflation, which fell further from 4.5% in November to 4.3%. This helped prevent a further increase in the headline reading. Another measure of core inflation, which includes transportation fuels and is monitored by the RBI (India's central bank), also slowed down - falling to 3.9% from 4.1% in November.

A sustained decline in core inflation over the last year suggests that the central bank's tight monetary policy is helping to contain demand-induced pressures. Lower commodity prices and falling logistics and business input costs are also reducing the core reading. On a quarterly basis, core inflation decreased to 5.4% in 4Q23, from 6.4% in 3Q23.

A separate data release showed that industrial production growth slowed to 2.4% year-on-year in November, from a downwardly revised 11.6% in October (11.7% previously). This result was below the consensus estimate of 3.5%. The sharp slowdown was due to seasonal distortions and the base effects of the timing of festive holidays. In 2023, the holidays took place in November, reducing the number of working days. In 2022, these holidays were in October.

This is unlikely to be a major concern for the central bank, since GDP growth has been surprisingly positive. The government's advance estimate of GDP growth for the year ending in March is 7.3%. This beats both the RBI's estimate of 7% and the consensus estimate of 6.6%. As the RBI's current focus is more aligned with reducing inflation to the medium-term target of 4%, policymakers will probably maintain the status quo in February, keeping a tight monetary policy stance.

Image 2: India CPI (%, YoY)

Source: Bloomberg

Image 3: 10-year yields

Source: Bloomberg, Refinitiv

Trade balance should also support the Rupee

India's trade deficit narrowed for the second month in December, after reaching a record high in October. The deficit fell to US$ 19.8 billion, from US$ 20.6 billion in November and US$ 31.5 billion the previous month.

The government's focus on manufacturing is likely to continue to encourage more domestic production. This should mean fewer imports, all things being equal. But faster economic growth will lead to more foreign purchases in general. Meanwhile, a global slowdown is likely to weigh on exports.

A trade deficit that remains close to the current modest level, together with positive investment flows, should bring stability to the rupee this quarter.

Image 4: Trade Deficit - India (USD billion)

Source: Refinitiv

In Summary

The Indian Rupee had a negative performance in 2023, largely due to a historically low interest rate differential against the US. However, the Indian economy has shown a robust growth trend, which gives rise to long-term optimism.

In addition, recent data also suggests a more positive scenario for the Indian currency in the short term. The recent acceleration in inflation should cause the RBI to start its interest rate cut cycle later than the Fed, raising the interest rate differential. The reduction in trade deficits should also strengthen the Rupee in the short term.

Weekly Report — Macro

Written by Alef Dias
alef.dias@hedgepointglobal.com
Reviewed by Pedro Schicchi
pedro.schicchi@hedgepointglobal.com
www.hedgepointglobal.com

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