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India Economy: Merchandise EXIM update - Expect depreciation pressure on rupee to continue

Trade deficit came off by ~US$5.2bn yoy to US$13.4bn: The yoy easing in trade deficit was led primarily by weaker imports rather than strong exports, similar to last two months. The sequential improvement in trade balance, however, was a combination of higher exports and lower imports. Overall, in light of escalating trade conflict and wave of global protectionism, we expect exports growth to be muted while consumption imports could see uptick post stimulus injection by the government. Combination of these events will lead to a widening bias in merchandise trade deficit for FY20, in our view.

Though July exports exhibited a mild sequential improvement in both petroleum and non-petroleum segments, moving average series continue to exhibit a downward momentum: July exports rose by US$1.3bn mom, led by both petroleum and non-petroleum segments. While this is encouraging, 6 month moving average growth for overall exports stands at 1.8%yoy, with a weakening momentum in the series (Exhibit 2). Though volume numbers come with a lag here, but June exports volumes declined by 2%yoy with a 0.5%yoy growth on a 6mma basis (exhibiting a sideways trend). Going forward, we believe any durable improvement in both - the moving average volume as well as value series would imply strength in underlying trend and we will be looking out for same.

Imports come off led by weaker oil prices as well as weaker non-oil, non-gold imports yoy: Jul-19 imports were down 10%yoy led by a 22% yoy decline in petroleum imports and a 2.2%yoy decline in non-oil, non-gold imports. Here also 6mma trends are exhibiting downward trend with 4%yoy decline in 6mma series for non-oil, non-gold imports.

Consumption-related imports took a hit post 2018, but we expect a recovery, as fiscal stimulus should support consumption: Our analysis of granular commodity-wise import data indicates that consumption-related imports took a hit in the latter part of 2018, at a time when the Indian economy was hit by a slowdown. This caused the share of consumption-related imports to slide to 12% in FY19 compared with 16% in FY18 (Exhibit 7, 8). While July 2019 data for all sub-categories is not available yet, the consumption share of overall merchandise imports in Apr-Jun 2019 stood at 11%. The decline in ex-oil and gold imports in July 2019 indicates that the slump in consumption-related imports should have sustained. We believe that the fiscal support to consumption (PM Kisan, tax rationalization and industry specific measures) and continued monetary stimulus should help in reviving this trend in FY20E.

Outlook: Global trade continues to see difficult times as US China trade talks fail to take shape, protectionism wave continues – thus impacting manufacturing output globally. India’s manufacturing sector is not insulated from current global conundrum. As a result we expect exports to continue to see a downward pressure in FY20/CY19. While consumption imports continue to be weak at the moment, we expect a reversal in this series led by ongoing monetary stimulus (as banks expected to pump up their retail lending, which will further fuel the leveraged consumption spend) and expected fiscal stimulus by means of tax rationalization and cash disbursals by the government. These two factors together are expected to put a widening pressure on merchandise trade deficit, consequently adding to a depreciation pressure on rupee. Consequently we expect rupee at to settle at an exchange rate of 72-73/USD over FY20. A risk to our call could be exceptional weakness in crude prices on account of weak global growth, thus putting a downward pressure on merchandise trade deficit and upward pressure on rupee.

Also, INR deprecation, higher government spending and bottoming out of core inflation will lead of hardening in Gsec yields, which has seen a severe flattening trend since Oct’18. India 10-year benchmark has already hardened to 6.63% from the recent lows of 6.3% and we maintain that it could further rise to 7% in the near future. Since we had largely anticipated this scenario, we have maintained our underweight (UW) position in PSBs and NBFC space.​