India’s resilience has undergone marked improvement

The past year or so has seen large global shocks—Russia-Ukraine war, aggressive rate hikes by major central banks, and the recent banking turmoil in US, to name a few. India, however, has largely held its ground. The rupee has stabilised over the past few months, equity and debt markets have avoided any sharp deterioration, and bank credit has sustained at decadal highs.

That’s a far cry from a decade ago—the taper tantrum of 2013—when mere news of the US Federal Reserve unwinding quantitative easing measures had led to a sharp depreciation of the rupee, and significantly tighter financial conditions in India. To be sure, many emerging markets have fared well amid the current round of global shocks, riding on reduced macroeconomic vulnerabilities and prudent and timely policy response.

India, which was a part of the ‘fragile five’ in 2013, has long exited that club. Indeed, in terms of its worst performance during market turmoil, the rupee depreciated a mere 2.6% against the US dollar in October 2022 compared with 6.3% as the taper tantrum played out. This, despite the fact that the Fed has not only exited quantitative easing but also hiked interest rates by 500 basis points (bps) within 15 months—a pace not seen since 1980—to 5-5.25%, the highest level since 2007. The unusually sharp pace of rate hikes has raised the spectre of market accidents, as evident from the collapse of small regional banks in the US in 2023. The risk tends to spill over to emerging markets through interconnected institutions and dent investor confidence.

So how is India managing such global headwinds? To be sure, capital inflows to India have weakened over the past year. Foreign portfolio investors (FPI) were net sellers for a second year in a row in Indian equity and debt markets in 2022-23. Foreign direct investments (FDI) also fell to a nine-year low. At the other end, India’s dependence on external funding has reduced. The current account deficit (CAD) has been declining since the second half of last year. Even at its peak of 3.8% of gross domestic product (GDP) in the second quarter of 2022-23, the CAD was lower compared with the taper tantrum period.

Falling crude oil prices have helped reduce the CAD, along with factors such as rising services exports and increased remittances from Indian workers overseas. Besides, India’s external debt has been stable at about 19% of GDP, lower than most of its BRICS peers (with the exception of China).

The Reserve Bank of India’s (RBI) interventions in the foreign exchange market helped curb rupee depreciation during the worst months in 2022-23. Yet, the central bank’s foreign exchange reserves have remained adequate to cover any major exigencies. The quantum of reserves is larger than India’s overall short-term liabilities, led by the CAD and short-term external debt, as the buffer has increased materially after 2013.

All these factors have tamed the rupee’s volatility and boosted the stability of other market segments. Moreover, these factors led monetary policy to focus on domestic developments. Even as the Fed and the European Central Bank continued to hike rates until May, RBI’s Monetary Policy Committee paused rate hikes in April. Over the past couple of months, inflation has remained within RBI’s target range even as it stood above central bank targets in western advanced economies. Back in 2013, inflation had touched double digits in India, while remaining muted in advanced economies.

India’s growth premium over advanced economies is high and expected to improve further. Between 2023-24 and 2026-27, Crisil expects India to grow at 6.7% per year. Over this period, S&P Global expects growth to average 1.4% in the US and 1.2% in Eurozone. Based on these projections, India’s growth differential over these economies will be 170bps above the average of the past decade. That will draw capital inflows, especially durable ones such as FDI, over the medium run.

FDI has already become the dominant form of capital inflows and has broadly been on a rising trend in the past decade, accounting for 57% of the net financial flows in 2021-22 compared with 22.2% in 2012-13 (excluding foreign exchange reserves). While they moderated to 40.5% of overall flows in the first three quarters of 2022-23, they were double those of 2012-13. FDI inflows support the resilience of the country’s external profile as these are typically affected less than FPI flows in a rising interest rate scenario.

Meanwhile, even as major central banks near the end of the rate hike cycle, the after-effects of elevated interest rates are playing out. Risks of market accidents remain high, especially as segments that benefitted from ultra-low rates and surplus liquidity in the past decade struggle to contain the impact of high interest rates. However, India seems well-poised to navigate through such global volatility. Falling crude prices should further bring down CAD to around 2% in 2023-24.

Structurally, too, India’s external profile looks better, as FDI imparts stability to capital inflows, the promising prospects of services exports, robust remittances, and improving overall growth prospects. In the milieu, we expect RBI’s interest rate pause to be sustained in June as inflation continues its descent, while the West, especially Europe, has some way to go before hitting the pause button on policy rates.

Dharmakirti Joshi & Pankhuri Tandon are, respectively, chief economist, and senior economist, Crisil.