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Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR
00
Keeping an eagle eye on two ‘I’s will be
imperative–Inflation and INR
December 2022
Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR
01
A year has passed since the US Federal Reserve first hinted at a taper tipoff (in November 2021). Since February, the Fed has hiked
policy rates by 3.75 percent. The Russia─Ukraine crisis, higher commodity prices, and the impending global slowdown weighed on
the economic fundamentals and outlook of all nations. India has not been spared as well and these events have led to a slower-
than-anticipated recovery in India. The country’s GDP grew by 6.3 percent year-over-year in the July–September quarter of FY23
(after the high growth of 13.5 percent in the April–June quarter buoyed by the low base effect). As a result, we have seen a strong
possibility of our growth projections being revised down by at least 0.3 ppts from our October forecast.
However, the RBI governor expressed confidence in India’s resilience during the monetary policy committee statement in October.
Comparative analysis suggests that India has done well in several economic parameters relative to Advanced Economies (AEs) and
a few Emerging Economies (EEs). However, its economic performance must improve relative to the peer EEs with whom the
country is competing for investment.
A key differentiator would be the course India takes in charting inflation and the INR currency (the two I’s) trajectories over the
next year. We believe that inflation is expected to be a menace for longer, due to relatively higher oil prices, a stronger US dollar
(USD), and supply chain interruptions in certain industries. Further, a stronger economic recovery may add to the overall pressure.
As we examine the curious case of INR currency, we expect the domestic currency trajectory to reverse with an improved domestic
demand outlook and stronger capital flows. The USD index may also retreat, as seen in the past. However, gains may get offset by a
weaker current account balance.
In the face of a global slowdown (implying slow export growth), could the possible solutions be reducing India’s import
dependence on non-essentials, looking for alternative import destinations, or increasing trade in its own currency?
Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR
02
India fared better on several
economic parameters
Across the world, policymakers have pivoted towards tighter monetary policies in a synchronised manner (except in a few
countries1
). The tightening of the policy rates has been aggressive in several countries, particularly in AEs, in terms of both
magnitude and frequency. The fact that AEs were far behind the normalisation curve due to the extraordinarily low policy rates for
too long, it was possible to raise rates by larger magnitudes. That was not the case with EEs (Figure 1).
Figure 1. A synchronised increase in policy rates across the world
Note: We have clubbed Taiwan and South Korea under AEs per the definition of WB and the IMF.
Source: Haver Analytics
1
China, Russia, Turkey, and Japan are the few nations that have either cut policy rates or have kept them untouched.
-1.0
0.0
1.0
2.0
3.0
4.0
5.0
Jan-21 Apr-21 Jul-21 Oct-21 Jan-22 Apr-22 Jul-22 Oct-22
% Policy rates in AEs
Australia Canada EU Japan
Korea UK US Taiwan
0
5
10
15
20
25
Jan-21 Apr-21 Jul-21 Oct-21 Jan-22 Apr-22 Jul-22 Oct-22
% Policy rates in EEs
Brazil China India Indonesia Malaysia
Mexico Russia Turkey Vietnam
Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR
03
As the US aggressively raised its policy rates, the interest rate differentials (the risk spread) between long-term US bonds and those
of other nations started narrowing. This led to the re-pricing of risks associated with bonds held outside the US, while investment
in US bonds became more attractive and safer. Consequently, the US became more attractive in terms of investment (Figure 2).
• The interest rate differential (the risk spread) between the US and India has narrowed despite the RBI raising policy rates to
control domestic inflation. This has been one of the causes of capital outflows, as seen in the past.
Figure 2. Interest rate differentials with the US are narrowing for most nations
Source: Haver Analytics
The potential impact of liquidity shortages and the prolonged geopolitical crisis reduced the risk appetite of institutional investors
worldwide. These investors started pulling money back to the US by selling risky assets (mostly those of the EEs initially) in favour
of US securities and cash. Soon AEs started feeling the heat too as their asset prices declined. None of the AEs captured in Figure 3
has seen a rebound yet. A few commodity-backed EEs have started showing some rebound lately.
• India has been amongst the better-performing nations in the equity markets since October 2022. Foreign Portfolio Investors
(FPIs) pumped in more than INR 36,239 crore in equities during November. Even FDI has seen an improvement since
September.
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-2
-1
0
1
Turkey
India
China
Malaysia
Indonesia
Brazil
Russia
Mexico
Japan
Taiwan
Canada
Korea
Australia
Germany
EU
UK
EEs AEs
Difference in rate
spread, YoY
Change in 10-year interest rate spread vis-s-vis US since last year
Risk spread
with US rate
gap
Risk spread
with US rate
gap widening
Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR
04
Figure 3. A few nations have seen their equity markets bounce back to levels a year back
Source: Haver Analytics
Investors have been selling assets and moving to the US, leading to significant capital outflows from the rest of the world. This has
led to an unrelenting rise in the USD index while currencies across the world have suffered against the USD (Figure 4). A
strengthening dollar not only reflects the higher demand for US fixed-income assets (because US financial markets become more
attractive and rising interest rates increase relative return on USD), but also the possibility of global slowdown risks. The tightening
monetary policy around the world is expected to reduce demand. China’s policy on mobility and the slowdown in the property
market has affected its economy.
• Even AEs are hit by USD’s appreciation to multi-decade highs in ways that were once more familiar to their EEs. Currencies in
AEs have depreciated faster than those in most EEs.
• Commodity-backed currencies, such as Brazil’s Reais, Mexico’s Peso, and Russia’s Rubles, performed strongly. As Russia is
trading oil in its own currency (due to international sanctions), its currency Ruble has become stronger.
• Worldwide, the depreciation of currencies against the USD is yet to bottom out (barring the commodity-backed currencies) as
the flight of capital to safety continues.
• INR has performed better; while the USD index increased by 11.9 percent, INR has depreciated by only 9.9 percent against
USD.
-50
-30
-10
10
30
Russia
Vietnam
China
Malaysia
Mexico
India
Indonesia
Brazil
Turkey
Taiwan
Korea
EU
Germany
Australia
US
Japan
Canada
UK
EEs AEs
%, YoY Domestic equity market index
Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR
05
-50
-40
-30
-20
-10
0
10
20
30
40
Turkey
Vietnam
Indonesia
India
Malaysia
Mexico
Brazil
China
Canada
Australia
Germany
Taiwan
EU
US
UK
Japan
EEs AEs
%, YoY Reserves in months of imports
Figure 4. The strengthening of USD has led to extreme volatility in currencies across the world
Source: Haver Analytics
Extreme volatility in currencies compelled policymakers of EEs to urgently intervene and correct the course of depreciation. Central
banks for almost all EEs dipped into their foreign reserves and sold-off US currencies to halt the local currency depreciation
(Figure 5).
• Due to foreign institutional investment outflows and the RBI’s intervention to support INR, India’s forex reserves declined from
13 months of import cover at the beginning of 2021 to 8 months. However, India is not in a worrisome situation as the country
has accumulated sizeable forex reserves over the years (despite having a current account deficit) by importing capital.
• After declining for months, Foreign Direct Investments (FDI) are showing signs of an uptick. Most importantly, there is a
healthy rise in FDI equity flows from Japan, Singapore, the UK, and UAE in H1 FY2022–23. This points to rising confidence
amongst global investors to invest in India and India’s inflows becoming more diversified.2
Figure 5. Central banks are trying to contain the currency volatility by dipping into their forex reserves
Source: Haver Analytics
2
https://dpiit.gov.in/sites/default/files/FDI_Factsheet_September_2022_0.pdf
-20
-10
0
10
20
30
Russia
Mexico
Brazil
India
Vietnam
Indonesia
Malaysia
China
Turkey
Canada
Australia
EU
Taiwan
UK
Korea
Japan
EEs AEs
National currency per
dollar, % YoY
Local currency per US dollar
Depreciation
72.1
Appreciation
Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR
06
India’s pain point - Inflation
Currently, significant uncertainties and low visibility on the outlook are impairing investment decisions. With time, investors will
eventually focus on economic fundamentals and cautiously move out of countries whose economic outlook does not look
promising in the long run. The most important criteria for risk assessment of an economy as an investment destination will be the
growth outlook and its stability.
Economies with high growth and controlled inflation (within the nation’s central bank’s target range) are considered low-risk and
high-return investment destinations. Strong growth increases the probability of higher returns on investment and low inflation
prevents erosion of the value of their investment returns in the long run. In Figure 5, economies are positioned relative to each
other based on their real economic growth and consumer price inflation outlook for 2023. Amongst EEs, China, Malaysia, Vietnam,
and Taiwan show relatively higher growth and lower inflation. Brazil, Russia, and Mexico are at the other extremes of growth and
inflation.
India scores high on growth. Even though the outlook is uncertain, the good news is that high GST and direct tax collections give
the government an ammunition to spend and cushion the impact of the impending global slowdown and keep the economy
buoyant.
The bad news is that inflation is expected to persist. Higher import costs due to global inflation and elevated oil prices, rising
service prices, and improved pricing power amongst producers are expected to translate into higher consumer prices. Higher food
prices will persist due to irregular Kharif pulses sowing and paddy production, and inconsistent monsoon in various regions that
affect vegetable prices. Core prices have been on the rise and inflation expectations barely show signs of moderation. That said,
the high-base effect will come into play next fiscal year (FY 23-24) and easing supply disruptions and softening commodity prices
may partly offset. The growth-inflation dynamics will continue to evolve and containing inflation for India will be imperative.
Figure 6. Growth and inflation projections for 2023 suggest India must make efforts to contain inflation
Source: Haver Analytics, Forecasts are from IMFWEO
Brazil
China
India
Indonesia
Malaysia
Mexico
Russia
Taiwan
Vietnam
Australia
Canada
EU
Germany
Japan
Korea
UK
US
0
1
2
3
4
5
6
7
8
9
10
-3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0
Inflation, % YoY
Growth (% YoY)
Growth and consumer prices in 2023
High growth,
controlled inflation
High growth, high
inflation
Negative growth, high
inflation
Negative growth,
controlled inflation
Turkey
Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR
07
The curious case of currency
volatility
The INR depreciation against USD will be another big concern as 86 percent of India’s trade is invoiced in dollars 3
. INR has been
fluctuating at 81–83 INR/USD, and according to analysts, it may not have bottomed out yet.
That said, INR has appreciated against other major currencies (EUR, Yen, and Pound) and against a few Southeast Asian peers,
including Malaysia and Taiwan (Figure 4). More importantly, Real Effective Exchange Rate (REER) has been steady, and Nominal
Effective Exchange Rate (NEER) is declining. This suggests that higher domestic inflation has been weighing on India’s
competitiveness against its trading partners.4
We believe that INR will gain some of its lost ground because the magnitude of depreciation has been lower than the appreciation
of the USD index (mentioned earlier). Besides, this is the first time in 20 years where INR has appreciated against major currencies,
while the REER has remained steady despite its depreciation against USD. In the event of a reversal in USD, and the possible
reversal of capital flows into the country (which we are already seeing signs of), INR will appreciate.
Figure 7. INR remains appreciated in real terms
Source: Haver Analytics
3
https://www.eximbankindia.in/blog/blogcontent.aspx?BlogID=9&BlogTitle=Dollar%20Dominance%20in%20Trade:%20Facts%20and%20Implications
4
The real effective exchange rate is a nominal effective exchange rate (such as the trade-weighted index) multiplied by the ratio of Indian prices to the prices ofour
trading partners. Since trade competitiveness is ultimately determined by changes in the price of Indian goods and services relative to foreign goods and services,
the REER can be a better measure of trade competitiveness than the NEER. It is often used in analytical work, whereas the other types of exchange rates are more
visible in our daily lives.
80
85
90
95
100
105
110
115
40
45
50
55
60
65
70
75
80
85
Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Jan-21 Jan-22
REER Index
INR/USD INR valuation
INR/USD REER
Currency depreciating
w.r.t. USD
Currency appreciating
w.r.t. trading partners
Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR
08
Possible implications
Not always a depreciated currency is bad for an economy. We can expect an increase in exports as we become more competitive.
One of the major beneficiaries would be the services sector. For instance, with rapid digitisation, India is expected to see a rise in
the export of technical services. A depreciated USD will make our IT services more competitive, and the same holds true for other
exporting sectors as well. With the rising emphasis on manufacturing, a competitive INR will only embolden India’s bid to attract
investors that are willing to diversify supply chains. Multiplier effects of policy initiatives and building infrastructure will kick in to
enhance export competitiveness.
The only challenge in this narrative is how demand for exports will shape up over the next year as the world economy slows down.
We expect a rebound in domestic demand despite a global slowdown next year and demand for imports to remain high. Expensive
imports would feed into higher inflation and lower purchasing power of consumers. Not to mention, a lower value of INR also
exerts pressure on imports and 86 percent of India’s imports are invoiced in USD.
India is expected to witness a very high Current Account Deficit (CAD). It is the only nation expected to see a sizeable rise in CAD
due to higher imports and slower exports. A widening CAD could put further pressure on INR valuation against USD (and one can
see a vicious cycle of depreciated INR and higher CAD at play). Consequently, foreign exchange reserves may fall further.
Figure 8. India’s current account is expected to worsen relative to other nations
Source: Haver Analytics, Forecasts are from IMFWEO
The pressure on INR is worrisome and India could deal with the situation by restricting imports of non-essentials or looking for
alternative cheaper import destinations. In July, the RBI announced the scheme permitting international trade settlement in INR.
Can this increase the demand for INR (raising its value) and help reduce India’s dependence on USD? Not anytime soon.
On the other hand, inflation will compel the RBI to keep the monetary policy tight. Higher inflation and borrowing rates will likely
hurt consumption and investment over the next year, thereby moderating the economic demand.
However, India’s resilience will help it sail through these uncertain times and recover at a steady pace. What will be critical is to
stay prepared for the time when the global economy recovers. India must do what it takes to keep the economic fundamentals
strong; it will not only help India stay ahead of its peers in the investment race but will also aid in a quick economic rebound when
uncertainties subside.
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1
3
5
7
9
11
13
15
Turkey
India
Brazil
Mexico
Vietnam
Indonesia
China
Malaysia
Russia
UK
US
Canada
Australia
EU
Japan
Korea
Germany
Taiwan
EE AE
% GDP Current account balance (% of GDP)
2019 2023
surplus
Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR
09
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to as “Deloitte Global”) does not provide services to clients. Please see
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This material is prepared by Deloitte Touche Tohmatsu India LLP (DTTILLP). This material
(including any information contained in it) is intended to provide general information on a
particular subject(s) and is not an exhaustive treatment of such subject(s) or a substitute to
obtaining professional services or advice. This material may contain information sourced from
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Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR

  • 1. Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR 00 Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR December 2022
  • 2. Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR 01 A year has passed since the US Federal Reserve first hinted at a taper tipoff (in November 2021). Since February, the Fed has hiked policy rates by 3.75 percent. The Russia─Ukraine crisis, higher commodity prices, and the impending global slowdown weighed on the economic fundamentals and outlook of all nations. India has not been spared as well and these events have led to a slower- than-anticipated recovery in India. The country’s GDP grew by 6.3 percent year-over-year in the July–September quarter of FY23 (after the high growth of 13.5 percent in the April–June quarter buoyed by the low base effect). As a result, we have seen a strong possibility of our growth projections being revised down by at least 0.3 ppts from our October forecast. However, the RBI governor expressed confidence in India’s resilience during the monetary policy committee statement in October. Comparative analysis suggests that India has done well in several economic parameters relative to Advanced Economies (AEs) and a few Emerging Economies (EEs). However, its economic performance must improve relative to the peer EEs with whom the country is competing for investment. A key differentiator would be the course India takes in charting inflation and the INR currency (the two I’s) trajectories over the next year. We believe that inflation is expected to be a menace for longer, due to relatively higher oil prices, a stronger US dollar (USD), and supply chain interruptions in certain industries. Further, a stronger economic recovery may add to the overall pressure. As we examine the curious case of INR currency, we expect the domestic currency trajectory to reverse with an improved domestic demand outlook and stronger capital flows. The USD index may also retreat, as seen in the past. However, gains may get offset by a weaker current account balance. In the face of a global slowdown (implying slow export growth), could the possible solutions be reducing India’s import dependence on non-essentials, looking for alternative import destinations, or increasing trade in its own currency?
  • 3. Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR 02 India fared better on several economic parameters Across the world, policymakers have pivoted towards tighter monetary policies in a synchronised manner (except in a few countries1 ). The tightening of the policy rates has been aggressive in several countries, particularly in AEs, in terms of both magnitude and frequency. The fact that AEs were far behind the normalisation curve due to the extraordinarily low policy rates for too long, it was possible to raise rates by larger magnitudes. That was not the case with EEs (Figure 1). Figure 1. A synchronised increase in policy rates across the world Note: We have clubbed Taiwan and South Korea under AEs per the definition of WB and the IMF. Source: Haver Analytics 1 China, Russia, Turkey, and Japan are the few nations that have either cut policy rates or have kept them untouched. -1.0 0.0 1.0 2.0 3.0 4.0 5.0 Jan-21 Apr-21 Jul-21 Oct-21 Jan-22 Apr-22 Jul-22 Oct-22 % Policy rates in AEs Australia Canada EU Japan Korea UK US Taiwan 0 5 10 15 20 25 Jan-21 Apr-21 Jul-21 Oct-21 Jan-22 Apr-22 Jul-22 Oct-22 % Policy rates in EEs Brazil China India Indonesia Malaysia Mexico Russia Turkey Vietnam
  • 4. Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR 03 As the US aggressively raised its policy rates, the interest rate differentials (the risk spread) between long-term US bonds and those of other nations started narrowing. This led to the re-pricing of risks associated with bonds held outside the US, while investment in US bonds became more attractive and safer. Consequently, the US became more attractive in terms of investment (Figure 2). • The interest rate differential (the risk spread) between the US and India has narrowed despite the RBI raising policy rates to control domestic inflation. This has been one of the causes of capital outflows, as seen in the past. Figure 2. Interest rate differentials with the US are narrowing for most nations Source: Haver Analytics The potential impact of liquidity shortages and the prolonged geopolitical crisis reduced the risk appetite of institutional investors worldwide. These investors started pulling money back to the US by selling risky assets (mostly those of the EEs initially) in favour of US securities and cash. Soon AEs started feeling the heat too as their asset prices declined. None of the AEs captured in Figure 3 has seen a rebound yet. A few commodity-backed EEs have started showing some rebound lately. • India has been amongst the better-performing nations in the equity markets since October 2022. Foreign Portfolio Investors (FPIs) pumped in more than INR 36,239 crore in equities during November. Even FDI has seen an improvement since September. -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 Turkey India China Malaysia Indonesia Brazil Russia Mexico Japan Taiwan Canada Korea Australia Germany EU UK EEs AEs Difference in rate spread, YoY Change in 10-year interest rate spread vis-s-vis US since last year Risk spread with US rate gap Risk spread with US rate gap widening
  • 5. Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR 04 Figure 3. A few nations have seen their equity markets bounce back to levels a year back Source: Haver Analytics Investors have been selling assets and moving to the US, leading to significant capital outflows from the rest of the world. This has led to an unrelenting rise in the USD index while currencies across the world have suffered against the USD (Figure 4). A strengthening dollar not only reflects the higher demand for US fixed-income assets (because US financial markets become more attractive and rising interest rates increase relative return on USD), but also the possibility of global slowdown risks. The tightening monetary policy around the world is expected to reduce demand. China’s policy on mobility and the slowdown in the property market has affected its economy. • Even AEs are hit by USD’s appreciation to multi-decade highs in ways that were once more familiar to their EEs. Currencies in AEs have depreciated faster than those in most EEs. • Commodity-backed currencies, such as Brazil’s Reais, Mexico’s Peso, and Russia’s Rubles, performed strongly. As Russia is trading oil in its own currency (due to international sanctions), its currency Ruble has become stronger. • Worldwide, the depreciation of currencies against the USD is yet to bottom out (barring the commodity-backed currencies) as the flight of capital to safety continues. • INR has performed better; while the USD index increased by 11.9 percent, INR has depreciated by only 9.9 percent against USD. -50 -30 -10 10 30 Russia Vietnam China Malaysia Mexico India Indonesia Brazil Turkey Taiwan Korea EU Germany Australia US Japan Canada UK EEs AEs %, YoY Domestic equity market index
  • 6. Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR 05 -50 -40 -30 -20 -10 0 10 20 30 40 Turkey Vietnam Indonesia India Malaysia Mexico Brazil China Canada Australia Germany Taiwan EU US UK Japan EEs AEs %, YoY Reserves in months of imports Figure 4. The strengthening of USD has led to extreme volatility in currencies across the world Source: Haver Analytics Extreme volatility in currencies compelled policymakers of EEs to urgently intervene and correct the course of depreciation. Central banks for almost all EEs dipped into their foreign reserves and sold-off US currencies to halt the local currency depreciation (Figure 5). • Due to foreign institutional investment outflows and the RBI’s intervention to support INR, India’s forex reserves declined from 13 months of import cover at the beginning of 2021 to 8 months. However, India is not in a worrisome situation as the country has accumulated sizeable forex reserves over the years (despite having a current account deficit) by importing capital. • After declining for months, Foreign Direct Investments (FDI) are showing signs of an uptick. Most importantly, there is a healthy rise in FDI equity flows from Japan, Singapore, the UK, and UAE in H1 FY2022–23. This points to rising confidence amongst global investors to invest in India and India’s inflows becoming more diversified.2 Figure 5. Central banks are trying to contain the currency volatility by dipping into their forex reserves Source: Haver Analytics 2 https://dpiit.gov.in/sites/default/files/FDI_Factsheet_September_2022_0.pdf -20 -10 0 10 20 30 Russia Mexico Brazil India Vietnam Indonesia Malaysia China Turkey Canada Australia EU Taiwan UK Korea Japan EEs AEs National currency per dollar, % YoY Local currency per US dollar Depreciation 72.1 Appreciation
  • 7. Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR 06 India’s pain point - Inflation Currently, significant uncertainties and low visibility on the outlook are impairing investment decisions. With time, investors will eventually focus on economic fundamentals and cautiously move out of countries whose economic outlook does not look promising in the long run. The most important criteria for risk assessment of an economy as an investment destination will be the growth outlook and its stability. Economies with high growth and controlled inflation (within the nation’s central bank’s target range) are considered low-risk and high-return investment destinations. Strong growth increases the probability of higher returns on investment and low inflation prevents erosion of the value of their investment returns in the long run. In Figure 5, economies are positioned relative to each other based on their real economic growth and consumer price inflation outlook for 2023. Amongst EEs, China, Malaysia, Vietnam, and Taiwan show relatively higher growth and lower inflation. Brazil, Russia, and Mexico are at the other extremes of growth and inflation. India scores high on growth. Even though the outlook is uncertain, the good news is that high GST and direct tax collections give the government an ammunition to spend and cushion the impact of the impending global slowdown and keep the economy buoyant. The bad news is that inflation is expected to persist. Higher import costs due to global inflation and elevated oil prices, rising service prices, and improved pricing power amongst producers are expected to translate into higher consumer prices. Higher food prices will persist due to irregular Kharif pulses sowing and paddy production, and inconsistent monsoon in various regions that affect vegetable prices. Core prices have been on the rise and inflation expectations barely show signs of moderation. That said, the high-base effect will come into play next fiscal year (FY 23-24) and easing supply disruptions and softening commodity prices may partly offset. The growth-inflation dynamics will continue to evolve and containing inflation for India will be imperative. Figure 6. Growth and inflation projections for 2023 suggest India must make efforts to contain inflation Source: Haver Analytics, Forecasts are from IMFWEO Brazil China India Indonesia Malaysia Mexico Russia Taiwan Vietnam Australia Canada EU Germany Japan Korea UK US 0 1 2 3 4 5 6 7 8 9 10 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0 Inflation, % YoY Growth (% YoY) Growth and consumer prices in 2023 High growth, controlled inflation High growth, high inflation Negative growth, high inflation Negative growth, controlled inflation Turkey
  • 8. Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR 07 The curious case of currency volatility The INR depreciation against USD will be another big concern as 86 percent of India’s trade is invoiced in dollars 3 . INR has been fluctuating at 81–83 INR/USD, and according to analysts, it may not have bottomed out yet. That said, INR has appreciated against other major currencies (EUR, Yen, and Pound) and against a few Southeast Asian peers, including Malaysia and Taiwan (Figure 4). More importantly, Real Effective Exchange Rate (REER) has been steady, and Nominal Effective Exchange Rate (NEER) is declining. This suggests that higher domestic inflation has been weighing on India’s competitiveness against its trading partners.4 We believe that INR will gain some of its lost ground because the magnitude of depreciation has been lower than the appreciation of the USD index (mentioned earlier). Besides, this is the first time in 20 years where INR has appreciated against major currencies, while the REER has remained steady despite its depreciation against USD. In the event of a reversal in USD, and the possible reversal of capital flows into the country (which we are already seeing signs of), INR will appreciate. Figure 7. INR remains appreciated in real terms Source: Haver Analytics 3 https://www.eximbankindia.in/blog/blogcontent.aspx?BlogID=9&BlogTitle=Dollar%20Dominance%20in%20Trade:%20Facts%20and%20Implications 4 The real effective exchange rate is a nominal effective exchange rate (such as the trade-weighted index) multiplied by the ratio of Indian prices to the prices ofour trading partners. Since trade competitiveness is ultimately determined by changes in the price of Indian goods and services relative to foreign goods and services, the REER can be a better measure of trade competitiveness than the NEER. It is often used in analytical work, whereas the other types of exchange rates are more visible in our daily lives. 80 85 90 95 100 105 110 115 40 45 50 55 60 65 70 75 80 85 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Jan-21 Jan-22 REER Index INR/USD INR valuation INR/USD REER Currency depreciating w.r.t. USD Currency appreciating w.r.t. trading partners
  • 9. Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR 08 Possible implications Not always a depreciated currency is bad for an economy. We can expect an increase in exports as we become more competitive. One of the major beneficiaries would be the services sector. For instance, with rapid digitisation, India is expected to see a rise in the export of technical services. A depreciated USD will make our IT services more competitive, and the same holds true for other exporting sectors as well. With the rising emphasis on manufacturing, a competitive INR will only embolden India’s bid to attract investors that are willing to diversify supply chains. Multiplier effects of policy initiatives and building infrastructure will kick in to enhance export competitiveness. The only challenge in this narrative is how demand for exports will shape up over the next year as the world economy slows down. We expect a rebound in domestic demand despite a global slowdown next year and demand for imports to remain high. Expensive imports would feed into higher inflation and lower purchasing power of consumers. Not to mention, a lower value of INR also exerts pressure on imports and 86 percent of India’s imports are invoiced in USD. India is expected to witness a very high Current Account Deficit (CAD). It is the only nation expected to see a sizeable rise in CAD due to higher imports and slower exports. A widening CAD could put further pressure on INR valuation against USD (and one can see a vicious cycle of depreciated INR and higher CAD at play). Consequently, foreign exchange reserves may fall further. Figure 8. India’s current account is expected to worsen relative to other nations Source: Haver Analytics, Forecasts are from IMFWEO The pressure on INR is worrisome and India could deal with the situation by restricting imports of non-essentials or looking for alternative cheaper import destinations. In July, the RBI announced the scheme permitting international trade settlement in INR. Can this increase the demand for INR (raising its value) and help reduce India’s dependence on USD? Not anytime soon. On the other hand, inflation will compel the RBI to keep the monetary policy tight. Higher inflation and borrowing rates will likely hurt consumption and investment over the next year, thereby moderating the economic demand. However, India’s resilience will help it sail through these uncertain times and recover at a steady pace. What will be critical is to stay prepared for the time when the global economy recovers. India must do what it takes to keep the economic fundamentals strong; it will not only help India stay ahead of its peers in the investment race but will also aid in a quick economic rebound when uncertainties subside. -5 -3 -1 1 3 5 7 9 11 13 15 Turkey India Brazil Mexico Vietnam Indonesia China Malaysia Russia UK US Canada Australia EU Japan Korea Germany Taiwan EE AE % GDP Current account balance (% of GDP) 2019 2023 surplus
  • 10. Keeping an eagle eye on two ‘I’s will be imperative–Inflation and INR 09 Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee (“DTTL”), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as “Deloitte Global”) does not provide services to clients. Please see www.deloitte.com/about for a more detailed description of DTTL and its member firms. This material is prepared by Deloitte Touche Tohmatsu India LLP (DTTILLP). This material (including any information contained in it) is intended to provide general information on a particular subject(s) and is not an exhaustive treatment of such subject(s) or a substitute to obtaining professional services or advice. This material may contain information sourced from publicly available information or other third party sources. DTTILLP does not independently verify any such sources and is not responsible for any loss whatsoever caused due to reliance placed on information sourced from such sources. None of DTTILLP, Deloitte Touche Tohmatsu Limited, its member firms, or their related entities (collectively, the “Deloitte Network”) is, by means of this material, rendering any kind of investment, legal or other professional advice or services. You should seek specific advice of the relevant professional(s) for these kind of services. This material or information is not intended to be relied upon as the sole basis for any decision which may affect you or your business. Before making any decision or taking any action that might affect your personal finances or business, you should consult a qualified professional adviser. No entity in the Deloitte Network shall be responsible for any loss whatsoever sustained by any person or entity by reason of access to, use of or reliance on, this material. By using this material or any information contained in it, the user accepts this entire notice and terms of use. ©2022 Deloitte Touche Tohmatsu India LLP. Member of Deloitte Touche Tohmatsu Limited Curabitur volutpat scelerisque leo et rutrum. Curabitur varius velit ut neque viverra malesuada. Cras id leo diam. Duis scelerisque vitae nisi in congue. Phasellus lobortis tellus ut gravida facilisis, ante enim rhoncus nibh, efficitur lobortis metus sem a mauris.