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Close monitoring of trade deficit, portfolio outflows warranted, says RBI article

The central bank said the views expressed in the article are those of the authors and do not necessarily represent the views of the Reserve Bank of India.

Close monitoring of trade deficit, portfolio outflows warranted, says RBI article
The article further said amidst all these developments, India's financial sector remains sound and stable. (File)

Amid hostile international environment, close and continuous monitoring of the widening trade deficit and portfolio outflows is warranted, strong reserve buffers notwithstanding, an RBI article has stated.

The article, authored by a team led by Deputy Governor M D Patra, however, took comfort from the fact that recent moderation in commodity prices and easing of supply chain pressures would help the nation in escaping the global inflation trap.

The Indian economy remains resilient in the face of formidable global headwinds, it said, but added “knock-on effects of geopolitical spillovers are visible in several sectors, tapering the pace of recovery.” The international environment “is hostile and hence, close and continuous monitoring of the widening trade deficit and portfolio outflows is warranted, notwithstanding strong reserve buffers, moderating external debt and a fairly valued exchange rate that has wilted less in the face the monotonic strengthening of the US dollar than many peers”, the article on state of the economy published in the RBI Bulletin for July said.

The central bank said the views expressed in the article are those of the authors and do not necessarily represent the views of the Reserve Bank of India.

“In spite of this overwhelming shock, there are sparks in the wind that ignite the innate strength of the economy and set it on course to becoming the fastest growing economy in the world, though besieged it might be by fears of recession,” it said.

In support of the argument, the authors said the recent revival of the southwest monsoon and rejuvenation of sowing activity has raised hopes of another bountiful year for agricultural activity, raising expectations that rural demand will soon catch up with urban spending and consolidate the recovery.

“The biggest source of relief is from inflation coming off its recent peak, albeit at an elevated level still. Nonetheless, the signs of its generalization and the potential unhinging of inflation expectations have elicited a pre-emptive and frontloaded monetary policy response,” they said.

The article further said amidst all these developments, India’s financial sector remains sound and stable.

If the commodity price moderation witnessed in recent weeks endures alongside the easing of supply chain pressures, the worst of the recent surge in inflation will be left behind, enabling the Indian economy to escape the global inflation trap and enjoy the fruits of the ebullient supply response that is taking place, it said.

India’s merchandise trade deficit widened to its highest monthly level of USD 25.6 billion in June 2022 as against a deficit of USD 9.6 billion a year ago and USD 24.3 billion in May 2022. On a quarterly basis too, April-June:2022-23 recorded the highest ever trade deficit of USD 70.3 billion.

In the foreign exchange market, the Indian rupee (INR) depreciated by 1 per cent vis-à-vis the US dollar (m-o-m) in June 2022 on the back of FPI equity outflows and strong US dollar.

This was also mirrored in the movement of the 40-currency real effective exchange rate (REER) which depreciated by 0.6 per cent in June 2022 over its level a month ago.

Foreign portfolio investors (FPIs) were net sellers in the Indian equity market for the ninth consecutive month in June, with an outflow of Rs 49,469 crore (highest monthly outflow since March 2020) and the sell-off continued in July (up to July 8, 2022) to the tune of Rs 3,716 crore.

Overall, FPIs have withdrawn Rs 1.2 lakh crore from the Indian equity market in 2022-23 so far, but the sell-off has been absorbed by domestic institutional investors (DIIs).

The article noted that India is set to become the most populous country in the world by 2023. According to the fifth round of the National Family Health Survey, 2019-21, released by the Ministry of Health and Family Welfare (MOHFW) in May 2022, however, India’s fertility rate – the number of children a woman bears in her child bearing life time – has fallen below 2.1, the rate at which the population can replace itself.

Also, COVID-19 infections have been rising in India with new mutations of the virus. High frequency indicators of economic activity are mixed. Green shoots of revival in contact-intensive services are breaking through.

Among other economic indicators, the article said that during April-May 2022, gross inward foreign direct investment (FDI) marginally decreased to USD 16.4 billion and repatriation of FDI increased to USD 5.0 billion from their levels a year ago (Chart 54).

Manufacturing, retail and wholesale trade, computer services, communication services and financial services received most of the investment and accounted for 76.7 per cent of the fresh equity flows.

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