COVID | Economics & Growth | Emerging Markets
India: Reopening 2.0 Stays on Track
- By Mirza Baig
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- 2 min read
India’s second re-opening is proceeding well. The pickup in activity is becoming broader based, while active Covid cases remain stable (Chart 1).
High-frequency indicators including GST collection, manufacturing PMIs, vehicle sales and power demand all improved in July relative to June. This normalization momentum will likely continue, supported by pent-up demand, increased vaccination, and high herd immunity attained through the pervasive outbreak in early summer.
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India’s second re-opening is proceeding well. The pickup in activity is becoming broader based, while active Covid cases remain stable (Chart 1).
High-frequency indicators including GST collection, manufacturing PMIs, vehicle sales and power demand all improved in July relative to June. This normalization momentum will likely continue, supported by pent-up demand, increased vaccination, and high herd immunity attained through the pervasive outbreak in early summer.
The external sector is doing especially well. Exports in July were 35% more than in July 2019. India is regaining the market share it lost to China in 2020, particularly in engineering goods and textiles. Thanks to strong external demand and the resumption of full economic activity, exports will probably hit an all-time high this year. India’s services exports, including software and outsourcing sectors, have also maintained steady growth (Chart 2).
The RBI is shifting gears on monetary policy. It took some baby steps to normalize liquidity at its MPC meeting on 6 August. While the central bank is keen to ensure stable bond yields to facilitate fiscal issuance, it is also worried about high core inflation and a positive inflation gap relative to its target. As such, its next steps are likely to fully normalize excess liquidity in Q4 and start hiking rates, possibly in Q1 next year.
There are risks to this, of course. A third Covid wave is one, despite the encouraging vaccination trends and prevalence of neutralizing antibodies in the populace. Heavy fiscal issuance will limit the RBI’s freedom and crowd out bank lending. A disruptive Fed tapering could also spill over via short-term capital flows. The health of consumer demand, after a pent-up surge, could disappoint, especially for those in the lower income brackets who were hit worst and have gone deeper into debt (Chart 3).
What does all this mean for the rupee? RBI intervention this year has frequently thwarted macro investors betting on a stronger rupee. As such, few expect the rupee to be ‘allowed’ to benefit from economic recovery. Some are downright bearish as they fear the current account could deteriorate as imports normalize and that the best of inflows is already behind us.
However, I am relatively optimistic on the back of the growth recovery and policy normalization. The 72.0–76.0 trading band of USD/INR may continue to hold for the rest of this year, but I think it could test the bottom of that range if the macro recovery stays on course (Chart 4). INR should perform better versus some other Asian currencies like PHP, TWD and IDR, and outperform versus a funder basket (EUR, JPY, TWD).
Mirza is a macro strategist, specialising in Asian FX and fixed income markets. Mirza is currently working as a desk analyst at Morgan Stanley, prior to which he worked in macro strategy roles at BNP Paribas and Deutsche Bank.