‘Risks Largely External': Crisil's DK Joshi On Decoding Global And Domestic Macro Signals

Within merchandise, our exports to the US and Europe have remained reasonably strong compared to Asia, pointed out DK Joshi, Chief Economist, CRISIL Ratings. “Our share of exports to the Asia-Pacific region has fallen from close to 34% in FY19 to around 26% right now. So that's quite a sharp fall in the share and this is to the fastest growing part of the world,” he said. 

One of the reasons behind this could be that India is not part of any major regional trade agreements, despite having free trade agreements with several countries in the region. “The benefits that you get from being a part of an overall free trade agreement, you possibly don't get from individual free trade agreements,” Joshi explained. 

“There are a lot of stress points emerging from the global economy and some of them are getting reflected in our external accounts,” Joshi further said, pointing to a higher-than-expected current account deficit. “Current account deficit is a signal of external vulnerability. If you have a current account deficit, you are more susceptible to volatility in capital flows and to currency weakening,” he said. 

There are also variables internally that need to be monitored, including inflation and falling household savings, but Joshi said that the risks currently are largely external, pointing to global oil prices and the aggressive tone from the US Fed and the European Central Bank, pointing to rising interest rates. 

For The Core Report’s weekend edition, Govindraj Ethiraj spoke to Joshi about external as well as internal macro signals that we should be monitoring. 

Here are edited excerpts from the interview: 

What are you looking at very carefully amongst the three or four signals that we talked about, whether it's remittances or oil prices and how it all connects with the current account deficit of India at this point or current account deficit in general?

As you rightly pointed out, I think there are a lot of stress points emerging from the global economy and some of them are getting reflected in our external accounts. Although I would say that our external accounts are still reasonably healthy. I mean the current account deficit is still in the safe zone. But yes, it did come a little higher than expected. And I think there are two pressure points there. One is the merchandise trade deficit, which has been negative for a while. I think it's always been negative. But now I think with the slowdown in exports, I think the trade deficit tends to widen because imports are more sticky in nature. Now that is putting some pressure on the current account deficit. 

What was a bit surprising was the remittance slowdown. There, I think if you look at the gross remittances, I think they haven't slowed down to that extent. It's the net. So there have been some outward flows also I think on the remittance front and I think that has led to net remittances, which get into the current account, so they have slowed down a bit. So I would be watching this space. I think the remittance part has been reasonably strong in India, even during Covid. After Covid the remittance flow has remained pretty strong. So I would not jump to the conclusion that the remittances are drying up as of now. But I think there is a need for vigil on that front now. 

The other thing is what the western Central Banks are going to do because inflation there is still not under control. And the aggressive tone from the US Fed, from the European Central Bank – they are all pointing towards rising interest rates. What matters most, of course, is what the US Fed does. And as a consequence of the aggressive tone from the Fed, the bond yields there have risen too much. So that means that the US bonds are becoming more attractive vis-a-vis other economies. So that leads to capital outflows, that strengthens the dollar. At the same time, I think as a consequence of that it also weakens other currencies. So we are watching that space right now. 

Currency volatility has been very well managed by RBI in the last fiscal year. I think if you see that was also a big stress year. Russia, Ukraine conflict, oil prices going up to $129, and we still manage pretty reasonable volatility in the currency, unlike during the global financial crisis. So the strong kitty with the RBI does give it some flexibility to manage the currency in an orderly fashion. The one thing that needs very close monitoring and which we are very exposed to is what happens to the oil. Despite the slowdown in the global economy, I think the prices of oil are rising and that's because of geopolitical reasons. The supply cuts by countries like Saudi Arabia, Russia, etc.,  which can maintain a pressure on oil. 

We import so much oil, I think that makes us extremely vulnerable to movements because it can hit your current account deficit, it can hit your fiscal deficit, it can cause inflation to go up. So there are many side effects of high oil prices that tend to play out whenever the oil prices go up and they remain there for a sustained period. So the key issue is not how much they are going to rise, but how long they are going to stay. Because last year also oil prices rose but they did not stay at that level for too long. A transitory pickup in oil prices is still manageable because our external obligations still continue to be reasonably under control. 

To pick up on oil specifically, so it's about $95 now, is there a danger mark that you would look for?

Above 90, oil sustaining at above 90 levels, I think creates a lot of stress for us. Just to give you an example – if oil prices go up by $10 a barrel, what happens is the current account deficit goes up by 0.4 percentage points, which is 40 basis points. So CAD to GDP will go up by 40 basis points. Similarly, I think the same increase in oil prices reduces the GDP growth by 20 basis points. So clearly I think there are strong effects. So every $10 a barrel is likely to have a symmetrical effect on the economy. 

Now, what might happen is that we may not pass on all the oil price increases into the economy. So you may keep inflation somewhat under control, but then your fiscal deficit will be under pressure because somebody has to subsidise that. 

If one can say so, what's the lesser evil in this? 

You have to basically balance to some extent, let’s say, what happens when oil prices go up? Its impact is either borne by the consumers, which is everything is passed on to the end consumer, or by the government, which means that they will raise their fiscal deficit, or by the oil marketing companies, which will reduce their profits. So what happens is, depending on where you are positioned, the burden gets shared by different participants. So at this juncture, I think my sense is that the burden will be shared less by the consumer because we are poll-bound here and more by the government and by oil marketing companies if oil prices remain high. I think that there's a big ‘if’ there.

Why is a high current account deficit an area of concern?

Well, current account deficit is a signal of external vulnerability, just as fiscal deficit is an area of concern for the domestic economy. For the external account, the current account deficit is a key matrix. If you have a current account deficit, I think you are more susceptible to volatility in capital flows. You are more susceptible to currency weakening. 

To give you an example, during the Taper Tantrum period, we had a high current account deficit and that is what made us more vulnerable. Because higher the current account deficit means you need more money from abroad to finance it. And I think that makes you more vulnerable. The lower it is, the less vulnerable you are. For India, below 2.5% of GDP is considered more or less in the safe zone. Once it starts rising above that level, it starts becoming a concern. 

You've also talked about and touched upon our falling merchandise exports, though our service exports are still strong, which is really IT companies and their exports. So is that something that we can park aside for the time being? 

We did some work on our export trends. Service exports, yes, I think we have a surplus. It sometimes moves up, sometimes moves down. But the merchandise, we always have a deficit. Now within merchandise, I think the trend is a little discomforting because our exports to the US and Europe have remained reasonably strong compared to Asia. Asia is the fastest growing part of the world. So I think our exports are slowing down to Asia much faster than slowing down to the West. It is something that needs to be corrected over a medium term. In the near term, with the global growth slowing down, your exports will be hit. That happens every time. So I don't think in the near term you can do much about it, but over the longer term we need to correct this imbalance. 

Just to give you an example, our share of exports to the Asia Pacific region has fallen from close to 34% in FY19 to around 26% right now. That's quite a sharp fall in the share and this is to the fastest growing part of the world. Which is why this needs to be reversed.

Do we know why that's happening? 

I think it's quite broad-based. One reason is that we are not part of any major regional trade agreement. So what we have done is we have done free trade agreements with many countries who are part of these agreements. The benefit of that will play out over some period. But the benefits that you get from being a part of an overall free trade agreement, you possibly don't get from individual free trade agreements. So that's a likely hypothesis. I think we need to see how it plays out because what's really interesting is that we are part of one free trade agreement with ASEAN and our trade has done reasonably well there. Even exports are holding up there. 

Let's come to the internal signals – we talked about inflation, which of course we're all tracking quite keenly. The new data point is savings and household savings or the proportion of that to GDP have fallen. Obviously, the proportion is also as important as the absolute. What are the internal signals that you are watching very carefully and the danger marks, if any? 

We are watching inflation closely because of two reasons. One, the food inflation part, which you alluded to now, within food inflation, the vegetable inflation has already been corrected, by the way, and tomatoes are selling at around Rs10 per kg. They were almost Rs 200-250 a kg about two months back. So the vegetable part, which is very volatile, has been corrected. 

Now the issue is with the cereals and pulses, where in pulses we have an area sown which is much lower than last year and overall sown area is only slightly above last year's level. So you need to expand your yields to be able to maintain growth in kharif production. 

With the abnormal monsoons, I think that becomes difficult. This is an El Nino year. The El Nino effect will continue towards the end of the year. So the concern is both on the Kharif output and also on the Rabi output because the reservoir levels are also a bit lower than what they were last year. Agriculture will remain a key monitorable and the government will have to play a very important role in shoring up the supplies in agriculture and keeping a lid on the prices. 

Having said that, the other worry that emerges is – the overall inflation is 6.8%. Actually, that will come to below 6% when the September data comes out. But the worry is if the fuel inflation actually picks up the baton from the food, I think then you have another trigger. The Central Banks typically don't worry about the supply shocks unless they are sustained, which means that if food inflation remains high, if crude-led fuel inflation remains high, then it tends to become generalised because the fuel inflation definitely goes through…it raises the consumer inflation directly and also indirectly because your transportation costs, your production cost, all of this tend to go up. So the worry for the Central Bank is that the shock that is coming from the supply side. It should not be generalised. So they have to be on the vigil on that front. 

Second is savings. But I must point out that this is only the financial savings part of the household savings. Household savings are close to 60% of the total savings in India. The corporates also contribute to savings and the government doesn't save anything. They dis-save because they run a deficit. So what we know right now is only the financial of the savings, which has fallen. And the physical savings are likely to have gone up because the liabilities of the households have also gone up and they are buying houses, they're buying automobiles et cetera. So clearly the gross savings have not fallen that much as the net savings have fallen. 

Gross savings are the overall savings of the households. Then what goes into the savings rate is the net savings. So you have to take the liabilities that households have created out which means the borrowings. The liabilities of the households have risen pretty sharply as a result the net savings have fallen extremely sharply. Now the data for physical savings and other parts of the savings will take time to come. My guess is that the household physical savings are likely to have gone up because these savings have been moving up and down quite a bit ever since the pandemic struck. 

What happened during the pandemic year was you saw very little opportunity for the households, so they saved a lot. The financial savings really shot up and went above the physical savings. After that the financial savings started coming down, the physical savings started going up and now with asset prices also going up there seems to be a trend towards physical savings. 

My sense is that this will correct itself but yes, financial savings falling is a matter of concern because they are usually preferred over physical savings. They can be very much easily intermediated for investments in the economy.

On the physical versus financial savings – over the weekend we've been seeing reports on house/ home sales in India hitting record highs for this quarter which is usually a slower quarter. So is this linked?

Yes, it is linked. People also want to hedge against inflation—so they go in for gold, they go in for physical assets. And if physical assets are appreciating in value then they return back to the physical savings. Actually the government has been taking steps to wean households more towards financial savings and to some extent this has also happened because we had financial inclusion that promotes financial savings. 

And then there are a lot of savings in the post office or savings in bank deposits. There are various avenues including stock markets. So you need to keep inflation low and the deficit under check to raise savings over a long period of time. If inflation is in check, then consumers don't feel the need to look for hedges against inflation. 

Is there anything else that we should be watching out for on the internal front?

These are the two major variables that popped up recently and I think they also caused a lot of curiosity. I am not too worried about the fiscal front. Actually government borrowing for the second half of the year is as they had budgeted. So there's no risk on the fiscal front right now. The risks are largely external in nature, which can mess up the math.

 

What is it that we should be more worried about? So these three or two or three external factors, the two or three internal factors, what is obviously more in our control and what is not? 

Overall we do believe India will do well this year. With the assumption that oil averages between 80 to 85, we project around 6% GDP growth. Inflation, which is somewhat higher than what was initially expected, we have a projection of 5.5%. So you need to keep a vigil on inflation. And it's not a cause of alarm. 

None of these are causing alarm right now. Only if the shock accentuates, I think then they will worry. It's time for more vigilance and less alarm right now. You need to watch the signals closely. The other part is the private investment cycle needs to take the pattern from the government. Because the government has been accelerating investments [but] it can't do it forever. So private investment should accelerate going ahead. 

We know that in an uncertain environment, private investment is a little cautious. We've watched the private investment part also pretty closely and it was getting broad based. And we do expect that over the next couple of years. I think the conditions are still ripe for private investments to continue on a stronger footing because the government can't support from the investment side. I think they have done more than enough in the last two, three years. 

Are you expecting some of these numbers, particularly domestic?

Yes, inflation we have a forecast of inflation at 5.7% for September which is lower than August, which will make the second quarter inflation at 6.6%. After that, in the second half of the year, with certain assumptions on oil, et cetera, we expect inflation to average around 5.4%. 

Clearly I do see inflation coming down, but the Central Bank wants inflation at 4% and we are still away from that target. So the Central Bank will also maintain vigil on that front. And in the upcoming policy in October we will see rates being maintained where they are – stance remaining withdrawal of accommodation and rates remaining higher for longer, which essentially means that we will not see rate cuts in this fiscal year. But in the beginning of the next fiscal is when we are pencilling some rate cuts. 

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