Indias forex reserves have continued to surge and crossed the $426 billion mark, thanks to an accretion of $1.22 billion during the week ended April 13 as per the latest WSS data (April 20, 2018) of RBI. This is an increase of $56 billion over last one year. In other words, Rs 3.6 lakh crore has been injected into the system by the reserve accretion in last one year.
The system had a liquidity hangover from demonetisation at the end of March 2017. Another liquidity injection of Rs 3.6 lakh crore would have worsened the situation.
How has this liquidity been absorbed? Let us look at the currency in circulation (CIC) figures, which have been responsible for the absorption of a major chunk of rupee liquidity. Currency in circulation has surpassed the pre-demonetisation level at Rs 18.45 lakh crore, a year-on-year growth by Rs 4.85 lakh crore over the previous year. The other contributor to the liquidity absorption has been incremental credit-deposit ratio, which ran at above 100 per cent through the year (FY18).
Credit growth of all scheduled commercial banks has been Rs 8.09 lakh crore in FY-18, which is 10.3 per cent on year-on-year basis. Against this, deposit growth has been quite anaemic at 6.7 per cent or, Rs 7.17 lakh crore, on a year-on-year basis with incremental credit- deposit ratio of 112.81 per cent. Deposit growth looks pale due to stronger base at the end of March 2017 on account of the demonetisation- induced Casa accretion.
Going forward, markets are going to be impacted strongly by liquidity stance. Minutes of the monetary policy committee (MPC) of RBI have been quite hawkish with statements like withdrawal of accommodation against the soundbytes of the members at the post-policy interactions, which were construed to be dovish.
The reaction is quite evident with yields retracting with vengeance. The benchmark 10-year yield nearly kissed the 7.80 per cent level, last seen in February. It corrected by 14 basis points the same day, but not without leaving a lasting bearish impact. The benchmark yield is likely to trade between 7.50 and 7.75 per cent levels as sentiments build up for next policy review in the first week of June.
Major factors that have been impacting the rates market are rising oil price, expected withdrawal of accommodation, consistently high core inflation (>5 per cent) and lower-than-expected GST collections.
The situation is improving on the GST front with stabilisation of revenue collections (it can only improve from here on with better compliance through e-way bill etc). Oil price rise is the biggest challenge to the fiscal math this financial year.
To contain consumer price inflation, governments at Centre and states will have to reduce excise duty and sales tax/ VAT. Every one rupee reduction in excise duty would result in a revenue loss of nearly Rs 14,000 crore or nearly 13 basis points of the projected GDP for FY19 of Rs 188 lakh crore. Being an election year, the probability of reducing excise duty with corresponding reduction in sales tax/ VAT by the states is quite high.
The USD-INR pair has got strength from the rising dollar index and outflows from foreign portfolio investors both in debt as well as equity segments. The pair has already crossed the 66-mark decisively. Trade deficit concerns continue to be high, though with the rupee depreciation and its move towards inflation-corrected parity, exports of primary goods from India may turn competitive.
With a boom in the global economy, services exports from India may witness strong growth. The CAD, or current account deficit, may continue to be under pressure in the short term but is likely to improve in the second half of the year with balancing of currency-led changes. In the short term, the rupee may test the 67 level to move towards inflation-corrected parity with the December 2014 level as a near-time base.