Stable INR thanks to the RBI

While India’s economy has also outperformed many of its peers, we aren’t putting this FX performance entirely down to structural factors, although the positive spread of policy rates over US rates is clearly helping. Rather, we think the stability of the currency all year is mainly due to Reserve Bank of India (RBI) intervention.

Normally, the INR tends to track according to inflation differentials, such that it maintains a more or less constant real exchange rate.

Indeed, there have been times this year when Indian inflation was lower than that of the US, and that could certainly have been consistent with a firmer currency. But more recently, apart from a relatively brief interlude a few months ago, the Indian inflation rate has pushed sharply higher again, while US inflation has consolidated at just over 3%, and the INR’s resilience is looking more questionable and less supportable now.

Saying this, there seems no shortage of ammunition for the RBI if it decides it wishes to persist with its INR support. Import cover is not only holding up well above the six months usually reckoned to be a minimum requirement for emerging market economies but has been rising recently.

FX Reserve import cover

The trade balance has deteriorated

This healthy FX reserves position hasn’t owed anything to the trade sector, which is currently running a deficit, though not a particularly large one by historical standards (the current account deficit is only about 2% of GDP).

Like everywhere else in the region, India’s exports have fallen from their 2021 peak, but it has been quite a slow decline, and India may have benefited from two factors. The first is that India’s direct trade with China is far more limited than most of the rest of Asia. The other is that India is not yet a big player in the semiconductor sector, which has been particularly hard hit this year, and which is only now troughing.

That said, India’s aggregate export performance relative to the rest of the region is not great, and it ranks towards the bottom of the pack in terms of relative year-on-year growth rates. This appears to be down to a couple of things. The first relates to what is usually very strong jewellery exports, which have been very soft this year. This is a big part of India’s export basket and accounted for about 8.5% of total exports in 2022. This is one area where weak Chinese demand could be having an outsized impact, as it is one of the largest markets for Indian jewellery after the United States, where demand has also been hit hard by high inflation rates.

India's exports by type

The second is bans on exports of agricultural products. Non-basmati rice exports were banned on 20 July, and this followed a ban last year of broken white rice last year. Exports of sugar after the current export season ends on 30 September will also add to the export gloom after sugar exports were capped at 6.1 million tonnes this season. Sugar exports have already almost stopped.

 Indian agricultural exports

Helping to square the circle between ongoing central bank support for the currency, export weakness and stable FX reserves, we can refer to the financial account of the balance of payments.

India's financial account (2Q moving average)