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India’s exposure to external funding risks has decreased with improvement in macro stability indicators, according to Morgan Stanley research report.
US 10-year yields have risen 158 bps since May—their sharpest rise since 2013—and are tracking at 16-year highs. At the same time, Indian 10-year yields have risen only 32 bps, in sharp contrast to 2013.
“The impact of higher US rates and/or tighter financial conditions flows mainly through the external balance sheet because India runs a current account deficit. As such, tighter global financial conditions weigh on the trend in capital flows, exposing the economy to external funding risks with resultant implications for domestic liquidity and/or financial conditions,” the report said.
The current account deficit (on a four-quarter trailing basis) has remained at or below 2.5 per cent of GDP since March 2014. It stood at 1.7 per cent of GDP as of June 2023 against 5 per cent of GDP as of June 2013.
Improved funding mix
FDI flows accounted for 47.5 per cent of capital flows in FY23 against 22.2 per cent in FY13. Other external stability indicators have also improved.
Import cover remains robust at 10.7 months and external debt has declined to 18.6 per cent of GDP as of June 2023 against 21.8 per cent of GDP as of June 2013.
“Inflation differentials between India and the US have narrowed, which also means that the real rate differential (on 10-year yields) is at 270 bps as of September 2023 (12-month trailing) vs. -280bps as of September 2013,” Morgan Stanley said.
Policy implications
“In our view, the RBI will remain focused on domestic inflation and growth dynamics as external stability indicators remain in the comfort range. We expect the current account deficit to remain below 2% of GDP in F24/F25e and inflation to moderate to 4.8% in F25e from 5.4% in F24e. As such, we expect the RBI to keep rates steady and focus on liquidity management in the near term. To the extent the inflation outlook is improving and real rates are expected to remain in positive territory, we expect a shallow rate cut cycle from 2Q24,” it added.
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