In this month, we focus on the outlook for global trade and its implications for India. With the Red Sea disturbance about to complete a full year, we take stock of trade activity along with a peak at maritime freight cost. This is followed by a quick assessment of US and India’s monetary policy along with the outlook on the Indian rupee.

1. Global trade to improve in 2025, but significant risks remain

Notwithstanding the elevated geopolitical uncertainty, global merchandise trade volume has expanded (as estimated by the CPB Netherlands) by 1.3% during Jan-Jul 2024 compared to an anaemic growth of 0.1% seen in the corresponding period in 2023. Bulk of this has come on the back of strong import demand from the UK and US along with strong export performance by China. Among major economies, Eurozone and to some extent Japan posted a disappointing performance on real merchandise trade activity in the first seven months of 2024.

We note that the World Trade Organization has upped its forecast for growth in global merchandise trade volume by 10 bps to 2.7% in its bi-annual assessment of global trade. This would be the best performance in the post COVID phase, barring 2021 that saw an exceptionally high growth as unlocking of economies allowed pent-up trade activity to pass through.

For 2025, while the WTO revised lower its forecast for world trade volume growth by 30 bps to 3.0%, it nevertheless indicates improvement over the 2024 momentum.

Moderation in global inflationary pressure has allowed many central banks to ease monetary policy. This should support consumption/investment, which in turn would help in a gradual recovery of global trade. However, the WTO acknowledges that significant downside risks remain, including regional conflicts, geopolitical tensions and economic policy uncertainty.

Chart 1: After a contraction in 2023, global merchandise trade volume is expected to recover in 2024 and 2025

From India’s perspective, the expectation of revival in global trade is comforting – after all, merchandise exports and services exports had a share of 12.4% and 9.6% in India’s GDP in FY 2023-24. We take a regional look at what could drive this revival from India’s perspective.

As per the WTO, growth in demand for imports on volume basis is expected to be the strongest for countries in Asia over 2024 and 2025. This is expected to be followed by countries in South America and North America. While the Middle East is expected to see strong demand in 2024, the same could peter out completely in 2025. Meanwhile, demand from Europe, CIS countries, and Africa is likely to remain subdued over 2024 as well as 2025.

Table 1: Regional heatmap depicting growth in volume of merchandise import demand

2. An update on the Red Sea crisis and shipping cost

It’s been almost one year since the Houthi movement started escalating with targeted attacks on ships crossing the Red Sea trading route (that is known to handle ~15% of global maritime trade). The attacks led many carriers to avoid the Red Sea route altogether, and opting for a detour with vessels going around the Cape of Good Hope in Africa. For most trade routes, rerouting via the Cape of Good Hope results in minimal delays, but Asia-Europe is an exception, experiencing additional travel time of 1-3 weeks compared to the more direct route via the Red Sea.

As per the current situation, as of Sep-24:

· Transit trade volume via the Bab-el-Mandeb Strait (a critical choke point in the Red Sea route that has seen concentration of attacks by the Houthis) was lower by 79.3% on annualized basis

· In contrast, the transit trade volume via the Cape of Good Hope (located at the southern tip of Africa) is up by 42.4% on annualized basis

Global maritime trade cost presents a mixed picture in 2024 so far. At one end, the Baltic Dry Index and the Baltic Tanker Index is down ~28% and ~23% in 2024 so far, the Baltic Container Index is up by a whopping ~170%. Although maritime freight volume carried by containers is about 13%, their share in the value of maritime trade is high at around 66%. Hence, although the sharp rise in container freight cost this year is unlikely to have a meaningful impact on the volume of maritime trade, it is bound to impact its overall cost.

The rise in freight costs can be attributed to several factors that include increased consumption demand, strikes in the transportation sector, shipping accidents, and extreme weather events. In recent months, the North American freight market has faced significant challenges such as a rail strike in Canada and the collapse of the Baltimore bridge. In last 6 months, China has faced disruptions in port activity on account of heavy fog and typhoons, while Malaysia and Singapore experienced delays due to heavy rainfall.

3. India’s export performance during the first half of FY 2024-25

As per preliminary estimates from the Ministry of Commerce, India’s merchandise exports grew at a tepid rate of 1.0% to USD 213 bn during Apr-Sep FY 2024-25 from USD 211 bn in the corresponding period in FY 2023-24. At a granular level:

· Top 5 items that recorded the fastest growth were Gold, Raw Silk, Silver, Aircraft/Spacecraft parts, and Computer hardware.

· Bottom 5 items in terms of growth were Wheat, Mollases, Processed Meat, Project Goods, and Wood products.

· The annualized share of Electronic items in India’s export basket currently stands at its highest level of 7.2%.

· The annualized share of Gems and jewellery items in India’s export basket currently stands at its lowest level of 7.1%.

Chart 2: There was wide variation in the performance of key export categories during Apr-Sep FY 2024-25

3. Monetary Policy Shift: Fed’s jumbo action to drive global rates lower

The US Federal Reserve finally joined the rate easing cycle with a jumbo sized 50 bps rate cut in Sep-24. More importantly, the Fed officials indicated at the possibility of another 50 bps rate before the end of 2024, followed by another 100 bps rate over the course of 2025. If realized, this will take the US monetary policy rate from its current range of 4.75-5.00% to 3.25-3.50% before the end of 2025.

With inflation moderation progressing at a gradual pace, the Fed now appears confident of meeting its inflation target in 2026. Meanwhile, although demand conditions appear relatively

healthy, gradual build-up of concerns has prompted the Fed to now start laying equal emphasis on its dual mandate of price stability and maximum employment.

The ongoing moderation in inflation pressures in 2024 over 2023 has prompted many central banks to start monetary easing. With the US Fed taking a bold and decisive step, other central banks might get influenced to replicate monetary policy easing actions in their respective economies. From India’s perspective, we note that the RBI shifted its monetary policy stance to ‘neutral’ from ‘withdrawal of accommodation’ in its Oct-24 policy review. While the shift in monetary policy stance happened without any change in the monetary policy rate (repo rate continues to remain at 6.50%), we believe it is a precursor for easing of interest rates in the near future. Depending upon the anticipated correction in domestic food prices and its overall impact on CPI inflation, market participants expect the RBI to deliver its first rate cut in either Dec-24 or Feb-25 policy review.

Chart 3: US monetary policy rate is set to decline further in 2025

4. Rupee view

The Indian rupee touched a record low as it breached the 84 level against the US dollar in Oct-24. The depreciation pressures are a culmination of the following factors:

· Broad based strength in the US dollar on account of a relatively better economic position of US vis-à-vis its peers

· Elevated geopolitical tensions in the Middle East and uncertainty on the prospects of global trade (esp. in the backdrop of upcoming US presidential election in Nov-24) have supported the safe haven demand for the dollar.

· Meanwhile co-ordinated policy easing in China is resulting in weakness in the Chinese yuan, which in turn is putting pressure on emerging market currencies

· Basis the RBI’s Real Effective Exchange Rate index (a trade weighted average exchange rate that adjusts for inflation differentials with the trading partner), the rupee is 7-8% overvalued compared to the long period average. As such, any depreciation in the currency helps to correct for the inherent overvaluation.

Despite the record weakness in the India rupee, the currency has seen extremely low levels of volatility. Relatively stable underlying macroeconomic balance characterized by high growth, moderate inflation, lower than trend trade deficit, correcting fiscal imbalances, and record high FX reserves bode well from the perspective of India’s global appeal and its currency stability.

Overall, we maintain our call of USDINR moving towards 84.5 levels by Mar-25.

Chart 4: Record weakness in the rupee spot rate is accompanied by record low volatility

5. CYTD price change in key commodity groups and shipping cost

The month of July has turned out to be important from two perspectives. On the domestic front, the central government presented the final budget for FY25, superseding the interim budget presented earlier in Feb-24. We parse through the signals to look at key takeaways along with implication for exporters. Meanwhile, expectations of commencement of monetary easing cycle (by the Fed and the RBI) and the presidential election season in the US are getting charged up. We take a quick look at what this holds for the rupee.

1. FY25 Union Budget prioritizes fiscal consolidation with micro boosters

On Jul 23^rd, the central government presented the final Union Budget for 2024-25, superseding the interim budget presented earlier in Feb-24. Since the NDA retained the office after the general election outcome, fiscal policy continuity was maintained. Key highlights:

• Acceleration of fiscal consolidation
  • The Finance Minister pruned the target for fiscal deficit to 4.9% of GDP from interim budget’s estimate of 5.1%. However, the incremental tightness in fiscal deficit will not be driven by pruning of expenditure. In fact, government’s expenditure bill is slated to increase to 14.8% of GDP, up from interim budget’s estimate of 14.6%. This has been possible on account of sharp increase in non-tax revenue with the RBI sharing record high dividend of Rs 2.1 lakh cr with the central government earlier this year.
• Prioritization of capital expenditure
  • Allocation for capital expenditure is set to touch a 20-year high of 3.4% of GDP in 2024-25 vis-à-vis 3.2% in 2023-24. Bulk of the capex allocation in 2024-25 will be geared towards the transport (esp. roads and railways) and defence sectors.

Chart 1: While fiscal deficit is set to reach its post pandemic low in 2024-25, allocation for capex is set to create a record multi-decade high

Source: Budget documents, CEIC, QuantEco Research

While that’s comforting from the perspective of overall macro stability and investor confidence, there were specific micro-boosters in the budget for supporting growth in targeted sectors like MSMEs.

• Availability of credit
  • The TARUN category of MUDRA loans will now see an enhanced limit of Rs 20 lakhs from Rs 10 lakhs earlier.
  • A new credit guarantee scheme, backed by the central government will be launched that will offer a guaranteed coverage up to Rs 100 cr per applicant.
  • To prevent MSME loans classified as SMA accounts by the banks, the government will provide additional credit support from a credit guarantee fund to prevent such loans from slipping into NPAs.
  • Over the next 3-years, SIDBI has been mandated to open 24 new branches, extending its services to 168 of the 242 major MSME clusters.
  • Public sector banks will now build in-house capability for assessment of MSME credit instead of relying on external assessment.
• Financial stability and ease of operations
  • The turnover threshold for buyers on the TReDS (Trade Receivables Discounting System) platform will be reduced from Rs 500 cr to Rs 250 cr, allowing 22 additional PSUs (public sector undertakings) and 7000 more companies to join the platform.
• Building infrastructure ecosystem
  • The government will establish E-Commerce Export Hubs through public-private partnerships (PPPs). These hubs will provide a range of trade and export-related services under one roof, enabling MSMEs and traditional artisans to market their products internationally.
  • The budget will provide financial support for setting up 50 multi-product food irradiation units and creating 100 NABL-accredited laboratories for quality, and safety testing units.

Chart 2: Although MSME ministry’s expenditure is set to moderate a tad, it remains significantly higher than its pre COVID levels

Source: Budget documents, CEIC, QuantEco Research

The measures outlined above will immensely benefit most exporters. In addition, the exporters would also gain from the announced reduction in custom duties (items illustrated in Table 1 below), that will help to boost cost competitiveness.

Table 1: Customs duty cuts in FY25 Union Budget will support domestic manufacturing, promote export competitiveness, and simplify taxation

Source: Budget documents, QuantEco Research

2. Monetary Policy: Moving closer to the beginning of the rate easing cycle

Along expected lines, the US Federal Reserve once again pushed back monetary easing expectations at its Jun-24 policy review. As per the latest projections by the Fed members, there is likely to be one rate cut before the end of 2024, down from the projection of two rate cuts predicted earlier in Mar-24.

However, with recent US economic data turning out to be softer than anticipated, market participants have priced in at least two rate cuts from the Fed (with the first cut in Sep-24) before the end of 2024. As such, the 1-year US Treasury bill rate has dropped by 30 bps since end Jun-24 to 4.79% currently.

In case of India, we believe the RBI will follow its own course and wait for food price volatility to subside after the completion of the 2024 south-west monsoon season (in which the Indian Meteorological Department projects a 6% surplus rainfall). A favorable monsoon outturn and range-bound commodity prices will enable to start easing monetary policy from Oct-Dec 2024, with likelihood of a cumulative 50 bps rate cut by Mar-25.

Table 2: Market participants expect at least 2 rate cuts from the US Fed in 2024

Source: CME, QuantEco Research

3. Rupee view

Notwithstanding gyrations in the global currency markets in recent months, the Indian rupee posted a stable performance in the financial year 2024-25 so far. With domestic general elections and the Union Budget pointing towards policy continuity, we expect the underlying macro-stability anchor for the rupee to remain intact.

From a flow perspective, INR is likely to remain in a comfortable zone:

• India’s current account deficit narrowed to 0.7% of GDP in FY24 (the lowest in the post COVID phase) from 2.0% in FY23. After adjusting for capital flows, the accompanying balance of payment registered a strong surplus of USD 64 bn in FY24.
• For FY25, we expect current account deficit to show a mild increase to 0.9% of GDP (though much lower than the long-term trend of 1.5%). However, expectation of recovery in FDI flows along with healthy FPI flows (amidst India’s inclusion in global bond indices) should help to generate a healthy BoP surplus of USD 50 bn.

Chart 3: Rupee has been one of the most stable currencies

Note: FYTD change is between 26-Jul-24 & 1-Apr-24; DM/EM imply Developed and Emerging Markets respectively

Source: CEIC, QuantEco Research

Meanwhile, global factors like uncertainty around the US presidential elections (to be held in Nov-24), geopolitical risks in the Middle East, and build-up of depreciation pressure on the Chinese yuan could potentially result in weakness for rupee. Overall, rupee’s 8-9% overvaluation, and RBI’s inclination for reserve accumulation would tilt the balance in favor of a mild depreciation. We maintain our call of USDINR moving towards 84.50 levels by Mar-25 vs. FY24 close of 83.43.

4. CYTD price change in key commodity groups and shipping cost

Note: (i) Price change is between Jul 26, 2024 and Dec 31, 2023; (ii) Oil price is represented by Brent; (iii) rounded off figures represented, (iv) While BDI has declined on CYTD basis, other shipping cost indicators like the VHBS ConTex Index has risen 163% on CYTD basis.

Data: CEIC, QuantEco Research

In this month, we look at the fragmentation of global merchandise trade, which would somewhat inhibit the extent of anticipated recovery in 2024. This is followed by a quick assessment of US and India’s monetary policy along with the outlook on the Indian rupee.

1. Global trade fragmentation

Notwithstanding the expectation of a moderate recovery in world merchandise trade in 2024 (which we elaborated upon in the May-24 newsletter), global trade activity has been continuously facing geopolitical headwinds. This trend that became noticeable with the start of US-China trade war in 2018 and picked up considerable momentum in the post COVID period, with many countries displaying protectionist tendencies. The calendar year 2023 saw a record number of harmful trade policy interventions by countries.

Chart 1: Trade protectionism has seen a sharp rise in last few years

Source: GTA, QuantEco Research

Since 2023, countries have used several motives to intervene on the merchandise trade front. The most common reasons cited are:

• Strategic competitiveness
• Climate change mitigation
• Resilience/ Security of supplies
• Geopolitical concern and national security

These trade policy interventions have given rise to both winners and losers across sectors. The table below lists Top 5 sectors under each category (since 2023).

Sectors affected by liberalising interventions	No. of interventions since 2023	Sectors affected by harmful interventions	No. of interventions since 2023
Machinery & parts	124	Iron & steel and its products	533
Cereals	70	Cereals	304
Vegetable oils	70	Fabricated metal products	276
Sugar & molasses	54	Unfinished products of copper, nickel, aluminium, lead, zinc, or tin	258
Grain mill products	52	Glass and its products	247

Source: GTA, QuantEco Research

From 2024 perspective, the outlook on world merchandise trade (as enumerated by multilateral agencies like the IMF and the WTO) is moderately encouraging. Exporters surveyed by The Economist expect 2.3% increase in export volumes (goods + services) in 2024 compared to a subdued growth of 0.7% in 2023. Having said, the exporters echoed the uncertainty of the current global trade environment by highlighting veracious limitations for expansion (Top 10 limitations are illustrated below in Chart 2).

Chart 2: What’s limiting exporters’ ability to expand?

Source: Economist, QuantEco Research

Interestingly, as a response to ongoing geopolitical shocks and in preparation for further escalation of geopolitical tensions that disrupt global trade, strategies like ‘friendshoring’ and the creation of dual supply chains are gaining prominence. The ‘China+1’ strategy is becoming more prevalent as businesses seek to diversify and reduce their dependency on a single region.

Chart 3: How are geopolitical events impacting global trade and supply-chains?

Source: Economist, QuantEco Research

2. Monetary Policy: Easing by the US Fed to get delayed

Along expected lines, the US Federal Reserve once again pushed back monetary easing expectations at its Jun-24 policy review. As per the latest projections by the Fed members, there is likely to be one rate cut before the end of 2024, down from the projection of two rate cuts predicted earlier in Mar-24.

While the pushback in the anticipated rate easing in US could have an impact on other emerging market economies, few central banks (like the central banks in Eurozone, Canada, Switzerland, Sweden, Brazil, Mexico, etc.) have taken the lead in kickstarting their monetary easing cycle. This highlights the importance of domestic macroeconomic conditions guiding central bank actions.

In case of India, we believe the RBI will also follow its own course and wait for food price volatility to subside after the completion of the 2024 south-west monsoon season (in which the Indian Meteorological Department projects a 6% surplus rainfall). A favorable monsoon outturn and range-bound commodity prices will enable to start easing monetary policy from Oct-24 onwards, with likelihood of a cumulative 50 bps rate cut by Mar-25.

Chart 4: Market participants expect 1-2 rate cuts from the US Fed in 2024

Source: Refinitiv, QuantEco Research

3. Rupee view

Notwithstanding gyrations in the global currency markets in last 2 months, the Indian rupee kickstarted the new financial year 2024-25 on a firm footing vs. the USD. With election uncertainty now behind, investors can now look forward to political and policy continuity. We expect the new government to continue prioritizing macroeconomic stability with focus on inclusive development.

From a flow perspective, INR is likely to remain in a comfortable zone:

• India’s current account deficit narrowed to 0.7% of GDP in FY24 (the lowest in the post COVID phase) from 2.0% in FY23. After adjusting for capital flows, the accompanying balance of payment registered a strong surplus of USD 64 bn in FY24.
• For FY25, we expect current account deficit to show a mild increase to 0.9% of GDP (though much lower than the long-term trend of 1.5%). However, expectation of recovery in FDI flows along with healthy FPI flows (amidst India’s inclusion in global bond indices) should help to generate a healthy BoP surplus of USD 50 bn.

Chart 5: India’s FY24 current account deficit was narrower than its long term trend; likely to remain so in FY25

Source: CEIC, QuantEco Research

Meanwhile, global factors like uncertainty around the US monetary policy trajectory and geopolitical risks could result in bouts of depreciation pressure. Overall, INR’s 6-7% overvaluation, and RBI’s penchant for reserve accumulation would tilt the balance in favor of a mild depreciation. We maintain our call of USDINR moving towards 84.50 levels by Mar-25 vs. FY24 close of 83.43.

5. CYTD price change in key commodity groups and shipping cost

Note: (i) Price change is between Jun 24, 2024 and Dec 31, 2023; (ii) Oil price is represented by Brent; (iii) Agriculture Items, Industrial Metals, and Precious Metals are represented by respective Bloomberg Commodity indices; (iv) rounded off figures represented.

Data: Refinitiv, QuantEco Research

In this month, we look at the performance of export credit in FY24 and its diminishing role. We extend our investigation into the Red Sea impact on India’s trade to pick up early signals. This is followed by a quick assessment of US and India’s monetary policy along with the outlook on the Indian rupee.

1. Diminishing role of export credit

Export credit registered its second consecutive contraction (-30% and -37% in 2022-23 and 2023-24 respectively), with the magnitude of outstanding credit slipping to Rs 12,900 cr for the year ending Mar-24. In value terms, this is the lowest level of export credit in last 17-years. More importantly, we note that the importance of export credit has been slipping over the years:

• In 2023-24, the share of export credit in total bank credit slipped to a record low level of 0.08%.
• The ratio of export credit to merchandise credit has fallen from its peak of 3.8% in 2007-08 to 0.4% in 2023-24.

Chart 1: Role of export credit in trade financing has diminished considerably

Source: RBI, CEIC, QuantEco Research

At a cursory level, we note that while India’s market share in global exports has improved since 2007-08 to its record high levels of 1.8-1.9% in 2023-24, the economy’s export intensity (captured by the ratio of merchandise exports to GDP) has moderated to 12.2% in 2023-24, which is marginally below its pre COVID levels of 12.5%, but significantly lower than its peak performance of 17.0% in 2011-12. The trend of improving market share coupled with reducing export intensity (on the merchandise side) is intriguing and needs to be researched and investigated in detail by the policymakers.

A reduction in export intensity at an economy wide level translates into a lower requirement for export credit. Having said, it is also possible that alternatives to bank-based export credit are now readily being availed by exporters.

Chart 2: India’s export intensity has reduced even though its’s export market share has improved

Note: Data for FY24 refers to the period Apr-Dec 2023

Source: RBI, WTO, CEIC, QuantEco Research

2. Is there any evidence of Red Sea impact on India’s merchandise exports?

Notwithstanding the ongoing disruption to global merchandise trade on account of geopolitical conflict in the Middle East region, India’s export performance has held up with annualized growth in merchandise exports improving to 2.9% in Jan-Mar FY24 over Oct-Dec FY24. This could be reflective of the impact of higher international commodity prices along with resilience in global demand (highlighted in our last month’s issue).

Since the start of the Red Sea disturbance in Dec-23, the underlying sequential momentum in India’s merchandise trade over Jan-Apr 2024 period has shown a mixed trend, with 2 out of 4 months exceeding the seasonal sequential benchmark, and vice versa (see table below). This points towards lack of any conclusive evidence of an adverse impact of recent geopolitical disturbances.

Table 1: Headline exports does not show any conclusive evidence of sub-par performance post the Red Sea disturbance

Note: (i) Month-over-month change is on the $ value of exports; (ii) Seasonal behaviour represents last 30Y median

Source: India’s Commerce Ministry, CEIC, QuantEco Research

A cursory look at India’s export destinations that exhibited weakness in the post Red Sea period (defined as more than 10 percentage point slide in annualized export performance in Jan-Mar FY24 over Oct-Dec FY24) indicates no conclusive evidence of systematic disruption – the geographical distribution of such export destination appears to be well spread.

Chart 3: Decline in demand India’s exports post the Red Sea disturbance shows a mixed geographical distribution

Source: India’s Commerce Ministry, CEIC, QuantEco Research

Having said, we note that the threat of Red Sea disruption remains alive. As per the FIEO (Federation of Indian Exporters’ Organisations), “delays and higher costs of shipping can lead to more order cancellations and hurt India’s competitive edge in global markets”. We would continue to track data in this space to arrive at early signals.

Table 1: Europe-Asia trade is the worst affected on account of Red Sea disturbance

Source: WTO, QuantEco Research

3. Monetary Policy: Easing by the US Fed to get delayed

Market expectations regarding Fed’s monetary policy trajectory remains on tenterhooks and is seen to be swaying with every notable surprise in key US economic data. Continued resilience in US activity data coupled with stickiness in inflation has already led to a significant pruning of market expectations of rate cuts from the Fed – the current pricing by futures market suggests likelihood of 1-2 rate cuts before the end of 2024, down from the expectation of 5-6 rate cuts at the beginning of the year.

This pushback in the anticipated rate easing in US could have an impact on other emerging market economies, like India. A surplus rainfall projected for the 2024 south-west monsoon season is preceded by (ongoing) severe heatwave conditions across India in Apr-Jun, that could cause some volatility in food price pressures in the near term. We expect the RBI to start easing monetary policy from Oct-24 onwards, with likelihood of a cumulative 50 bps rate cut by Mar-25.

Chart 4: Market participants expect 1-2 rate cuts from the US Fed in 2024

Source: Refinitiv, QuantEco Research

4. Rupee view

Notwithstanding gyrations in the global currency markets in last 1-2 months, the Indian rupee kickstarted the new financial year 2024-25 on a firm footing vs. the USD. Although the general election cycle is currently underway, we believe the overall policy backdrop of macroeconomic stability is likely to prevail in near-to-medium term. While this would continue to provide a stable underpinning to the INR, global factors like uncertainty around the US monetary policy trajectory and geopolitical risks could result in bouts of depreciation pressure. Overall, INR’s 6-7% overvaluation, and RBI’s penchant for reserve accumulation would tilt the balance in favor of a mild depreciation. We maintain our call of USDINR moving towards 84.50 levels by Mar-25 vs. FY24 close of 83.43.

5. CYTD price change in key commodity groups and shipping cost

Note: (i) Price change is between May 21, 2024 and Dec 31, 2023; (ii) Oil price is represented by Brent; (iii) Agriculture Items, Industrial Metals, and Precious Metals are represented by respective Bloomberg Commodity indices; (iv) rounded off figures represented.

Data: Refinitiv, QuantEco Research

In this month, we focus on the outlook for global trade and its implications for India. This is followed by a quick assessment of US and India’s monetary policy along with the outlook on the Indian rupee.

1. Global trade to rebound in 2024, but risks remain

First, the good news. As per the World Trade Organization’s Global Trade Outlook and Statistics report (Apr-24), compared to a contraction of 1.2% in 2023, world merchandise trade volume is projected to expand by 2.6% in 2024 and further by 3.3% in 2025. As per the agency, easing of global inflationary pressures and the concomitant increase in household incomes should help support demand for merchandise trade in 2024 and 2025.

Chart 1: After a contraction in 2023, global merchandise trade volume is expected to recover in 2024 and 2025

Note: Values for 2024 and 2025 are forecasts by the WTO

Source: WTO, QuantEco Research

A similar portrayal is also done by the International Monetary Fund, in their World Economic Outlook presented in Apr-24. As per their forecasts, volume of global trade (goods+services) is set to expand by 3.0% and 3.3% in 2024 and 2025 respectively after a subdued growth of 0.3% in 2023.

From India’s perspective, the expectation of revival in global trade is comforting – after all, merchandise exports and services exports had a share of 12.5% and 9.7% in India’s GDP in CY2023. We take a regional look at what could drive this revival from India’s perspective.

As per the WTO, growth in demand for imports on volume basis is expected to be the strongest for countries in Asia over 2024 and 2025. This is expected to be followed by countries in South America and Africa. Demand for imports is likely to be the weakest from the CIS group of countries in 2024 and 2025, followed by the European and Middle East countries.

Table 1: Regional heatmap depicting growth in volume of merchandise import demand

Note: (i) Figures in parenthesis lists the region’s share in India’s merchandise exports in 2023 in percentage terms, (ii) Asia includes Oceania

Source: India’s Commerce Ministry, WTO, QuantEco Research

Notwithstanding the optimistic outlook for global trade, there are unpredictable downside risks due to current geopolitical conflicts (esp. in the Middle East/ West Asia region) and trade policy uncertainty (esp. involving US and China). Notably, while the trade volume forecasts by the WTO and the IMF for 2024 suggest recovery, both estimates were marked down by 70 bps and 50 bps respectively vis-à-vis their previous forecast levels provided in Oct-23.

2. A quick round-up of India’s export performance in FY 2023-24

As per preliminary estimates from the Ministry of Commerce, India’s merchandise exports contracted by 3.1% to USD 437 bn in FY 2023-24 from USD 451 bn in FY 2022-23. At a granular level, there were wide variations in category wise export performance.

• Electronic items grew at the fastest pace, with its annualized share in the total export basket scaling an all-time high of 6.7%.
• Stone, Plaster, Cement, etc. did well as a category, which helped its annualized share in the total export basket touch 1.0%.
• Meanwhile, Leather, Gems & Jewellery, Plastic & Rubber, and Textiles saw their share in the total export basket dip to an all-time low of 1.0%, 7.5%, 1.8%, and 7.4% respectively.
• With respect to incremental change in sectoral shares, while Electronics saw the biggest increase, Petroleum products saw the largest decline.

Chart 2: Despite contraction at an aggregate level, there was wide variation in the performance of key export categories in FY 2023-24

Source: Ministry of Commerce, QuantEco Research

2. Monetary Policy Shift: Easing by the US Fed to get delayed

Since our last update in Mar-24, there has been a considerable reassessment of market expectation with respect to the monetary policy trajectory in the US. Continued resilience in US economic data has started to cast doubt whether the entire cumulative rate cut of 225 bps as indicated by the latest Fed official’s projection for 2024-2026 period would be needed to glide Core PCE inflation towards its target of 2.0% by 2026.

The recent hardening of global crude oil prices has further dampened the outlook for near term inflation prospects.

As such, market participants have scaled back their expectation of imminent monetary easing by the US Fed. The futures market currently indicates the probability of just under two round rate cuts before the end of CY 2024. This is lower than the expectation of at least three round of rate cuts for 2024, just about a month back. We now expect the Fed to begin cutting rates from Sep-24 onwards, with possibility of up to 75 bps cumulative rate cut by Mar-25.

This pushback in the anticipated rate easing in US could have an impact on other emerging market economies, like India. A surplus rainfall projected for the 2024 south-west monsoon season will be preceded by (ongoing) severe heatwave conditions across India in Apr-Jun, that will potentially stoke food price pressures in the near term. As such, we now expect the RBI to start easing monetary policy from Oct-24 onwards, with likelihood of a cumulative 50 bps rate cut by Mar-25.

3. Rupee view

The Indian rupee clocked a mild depreciation of 1.5% against the US dollar in FY 2023-24. This was accompanied by subdued volatility, both from a historical perspective, as well as compared to key currency peers across the DM (developed markets) and EM (emerging markets) FX space. Our baseline view for FY25 mirrors the outturn in FY24, i.e., the likelihood of a mild depreciation accompanied by subdued volatility.

In recent weeks, global factors have turned adverse on the margin:

• Resilience in US economic data has pushed back expectations of monetary policy easing by the US Fed, as discussed above. This has provided a leg up to the US dollar, which in turn has weighed upon emerging market currencies, including the Indian rupee.
• Escalation of geopolitical conflict in the Middle East/ West Asia region is providing an upside to the US dollar (as it enjoys a safe haven status) as well as crude oil prices (this could potentially weigh upon the rupee as oil accounts for ~40% of India’s merchandise trade deficit).

These risks could get partly offset on account of resilience in India’s underlying macro-stability parameters, our forecast of a Balance of Payments surplus in FY 2024-25, and expectation of a recovery in global trade, as discussed above.

Overall, we maintain our call of USDINR moving towards 84.5 levels by Mar-25.

Chart 3: While total trade deficit remains moderate, portfolio inflows have lost momentum in recent weeks

Source: CEIC, QuantEco Research

Note: FPI flow data for Apr-24 is until 21^st

4. CYTD price change in key commodity groups and shipping cost

Note: (i) Price change is between Apr 19, 2024 and Dec 31, 2023; (ii) Oil price is represented by Brent; (iii) Agriculture Items, Industrial Metals, and Precious Metals are represented by respective Bloomberg Commodity indices; (iv) rounded off figures represented.

Data: Refinitiv, QuantEco Research

Last few weeks saw hectic activity in the sphere of policies with respect to global trade. We take a cursory look at the key developments. This is followed by a quick assessment of US and India’s monetary policy along with the outlook on the Indian rupee.

1. Implications of recent trade related policy developments

During the last few weeks, India participated in three global trade related policy developments, viz., WTO’s 13^th Ministerial Conference, India-EFTA Trade and Economic Partnership Agreement, and Indo-Pacific Economic Framework for Prosperity. Below, we highlight key takeaways from each:

WTO’s 13^th Ministerial Conference (MC13)

The WTO’s MC13 meet that concluded on Mar 2^nd with participation from 166 trade ministers saw the acceptance of the Abu Dhabi Declaration, which turned out to be rather underwhelming. Geopolitical uncertainty (like wars involving Russia-Ukraine and Israel-Hamas), slowdown in few economies, and pending elections in several countries in 2024 posed headwinds, with the MC13 failing to conclude several areas of negotiations. To highlight, deals on fisheries and agriculture remains open while consensus on WTO’s dispute settlement architecture is yet to be formed. However, negotiations on the extension of the e-commerce moratorium offered a silver lining.

From India’s perspective, we note that:

• The current stance on MSP (Minimum Support Price) and PSH (Public Stock Holding) was maintained with no commitment towards reduction in farm subsidy unless WTO delivers a permanent solution on PSH for all members and protects the treaty-embedded Special and Differential Treatment provision in the Agreement on Agriculture.
• The stance on fisheries was maintained as no restrictions within the EEZs (Exclusive Economic Zones) for preserving livelihood and food security.
• India opposed duty-free digital transmission to safeguard against potential revenue losses amidst the need for supervising growing digital trade.

India-EFTA Trade and Economic Partnership Agreement

After over a decade of negotiations, India signed the Trade and Economic Partnership Agreement with EFTA countries (comprising Switzerland, Iceland, Norway & Liechtenstein) on Mar 10^th. The TEPA with EFTA countries is unique as:

• This is India’s first FTA with four developed nations
• For the first time in history of FTAs, binding commitment of USD 100 bn FDI and 1 mn direct jobs in the next 15 years has been given by the EFTA countries

The agreement comprises of 14 chapters with main focus on market access related to goods, rules of origin, trade facilitation, trade remedies, sanitary and phytosanitary measures, technical barriers to trade, investment promotion, market access on services, intellectual property rights, trade and sustainable development and other legal and horizontal provisions.

Under this deal, India will reduce most import tariffs on processed food and beverages along with electrical machinery items, pharmaceutical products, and medical devices (gold imports will not receive any tariff concession) from the four countries in return for investments over 15 years. The investments are expected to be made across a range of industries, including pharmaceuticals, machinery, and manufacturing.

As per India’s Ministry of Commerce, the FTA will provide a window to Indian exporters for improved access to the European market. In addition, the FTA aims to provide Mutual Recognition Agreements in professional services (such as Nursing, Chartered Accountancy, and Architecture) for cross-border exchanges and collaborations while also boosting agreements in services like IT, Business, Culture, and Education.

Indo-Pacific Economic Framework for Prosperity (IPEFP)

India along with its other IPEFP partners had their first ministerial meeting on Mar 14^th. IPEFP was launched in May-22, bringing together 14 regional partners (Australia, Brunei, Fiji, India, Indonesia, Japan, Korea, Malaysia, New Zealand, Philippines, Singapore, Thailand, US, and Vietnam) – in a new model of economic cooperation. While the Framework is not a trade agreement/treaty, it nevertheless seeks to advance cooperation across four key pillars of Trade, Supply Chains, Clean Economy, and Fair Economy.

India has signed a supply chain resilience agreement with the US and 12 other members of the IPEFP to reduce its dependence on China. It has so far stayed away from the trade pillar of the Framework.

Table 1: India currently has 18 key trade agreements on bilateral and multilateral basis

Note: There is often a lag between signing of a trade agreement and its implementation

Source: India’s Commerce Ministry, PIB, US International Trade Administration, Media reports, QuantEco Research

Table 2: India currently has 10 key ongoing trade negotiations on bilateral and multilateral basis

Note: As per media reports, negotiations with EU and UK are at an advanced stage

Source: India’s Commerce Ministry, PIB, QuantEco Research

2. Outlook on monetary policy

Along expected lines, the US Fed left its policy rate unchanged (in the 5.25-5.50% range) at its policy review on Mar 20, 2024. However, there were few noticeable changes in the FOMC (Federal Open Market Committee) projections:

• The outlook for growth saw an upgrade across 2024-2026. The most sizeable upward revision was seen in case of 2024, with GDP growth now projected at 2.1% vs. the earlier projection of 1.4% in Dec-23.
• The forecast for unemployment rate in 2024 and 2026 saw a minor downward revision to 4.0% from 4.1% projected earlier in Dec-23.
• Forecast for Core PCE inflation for 2024 saw an upward revision to 2.6% from 2.4% projected earlier in Dec-23.
• Last, but not the least, the median projection for fed funds rate for 2024 stood unchanged at 4.6%. This maintains the likelihood of 75 bps cumulative rate cut from the Fed before the end of 2024. In contrast, the projection for fed funds rate for 2025 and 2026 saw an upward revision to 3.9% and 3.1% from its earlier projection of 3.6% and 2.9% respectively in Dec-23.

Market pricing of US interest rate as per the futures market is currently in sync with the latest set of FOMC projections. We maintain our expectation of the first rate cut from the US Fed to begin from Jun-24 onwards.

With this as a backdrop, other key central banks could also begin their rate easing cycle with a lag (among developed countries, the Swiss National Bank (SNB) has in fact taken the lead, by announcing its first rate cut in Mar-24). In case of India, as CPI inflation starts providing durable comfort in the coming quarters, we expect the RBI to start its monetary easing cycle. With government recently announcing a series of fuel price cuts (Rs 100 per cylinder on LPG, Rs 2.1 per litre on diesel, and Rs 2.0 per litre on petrol), the RBI’s FY25 CPI inflation estimate of 4.5% could see some downside adjustment. As such, we now bring forward our expectation of the first rate cut from the RBI to Aug-24 from Oct-24 earlier, while maintaining the likelihood of 75 bps cumulative rate cut by Mar-25.

Table 3: In last 3-months, there has been an increase in Fed’s optimism with respect to the US economy

Source: Federal Reserve, QuantEco Research

3. Rupee view

After three consecutive months of mild appreciation, INR has reversed direction, and is currently trading 0.6% weaker against the USD in the month of Mar-24 so far. While INR was behaving in line with its favorable financial year-end seasonality and had strengthened somewhat in the first 2-3 weeks of Mar-24 (touching 82.75 on Mar 11^th vs. 82.91 on Feb 29^th), the reversal happened post the US Fed policy outcome, and more importantly after the SNB’s surprise rate cut, dilution of Bank of England’s hawkishness, and market expectations of a rate cut from the People’s Bank of China. While the USD appears to be on a rather neutral turf post the Mar-24 FOMC meet, expectation of monetary easing is weighing upon CNY, which in turn is adversely impacting other emerging market currencies, including the INR.

While we still believe that INR will be supported by favorable financial year-end trade seasonality along with healthy portfolio inflows (India has received USD 5.8 bn FPI inflow in Mar-24 so far), last few days of price action in the global currency market has added upside risk to our Mar-24 INR call of 82.5.

Having said so, we do maintain our medium-term view of a mild depreciation in INR, with likelihood of 84.5-85.0 by Mar-25. RBI’s proactive FX intervention should continue to remain a key source of suppression in INR volatility.

Chart 1: In recent months, INR has found support from narrowing of total trade deficit along with healthy portfolio inflows

Source: CEIC, QuantEco Research

Note: FPI flow data for Mar-24 is until 21^st

4. CYTD price change in key commodity groups and shipping cost

Note: (i) Price change is between Mar 15, 2024 and Dec 31, 2023; (ii) Oil price is represented by Brent; (iii) Agriculture Items, Industrial Metals, and Precious Metals are represented by respective Bloomberg Commodity indices; (iv) rounded off figures represented.

Data: Refinitiv, QuantEco Research

The month of Feb-23 started with the presentation of the interim budget for 2024-25. We parse through the signals to look at key takeaways along with implication of exporters. This is followed by a quick assessment of US and India’s monetary policy along with the outlook on the Indian rupee.

1. FY25 Interim Budget prioritizes fiscal consolidation

The central government presented the 2024-25 interim budget (this will be superseded by the normal budget post the new government formation in Jun/Jul 2024) on Feb 1^st, 2024. Although this was a vote-on-account, the Finance Minister clearly emphasized on the policy priority of maintaining macroeconomic soundness via two primary avenues:

• Accelerating the process of fiscal consolidation
  • After revising lower the fiscal deficit target for 2023-24 to 5.8% of GDP from 5.9% earlier, the interim budget consolidated further, with target for fiscal deficit budgeted at 5.1% of GDP for 2024-25, lower than market expectation of 5.2-5.4%.
• Prioritization of capital expenditure
  • Allocation for capital expenditure is set to increase to a 20-year high of 3.4% of GDP in 2024-25 vis-à-vis 3.2% in 2023-24. Bulk of the capex allocation in 2024-25 will be geared towards the transport (esp. roads and railways) and defence sectors.

Chart 1: While fiscal deficit is set to reach its post pandemic low in 2024-25, allocation for capex is set to create a record multi-decade high

Source: Budget documents, CEIC, QuantEco Research

While that’s comforting from the perspective of overall macro stability and investor confidence, specific allocation towards external trade (under the Department of Commerce) saw a sizeable pruning.

• Specific trade related expenditure is set to contract by 41% in 2024-25 after witnessing a 16% contraction in 2023-24
  • Bulk of the contraction budgeted in 2024-25 is an account of lower allocation for Interest Equalisation and Duty Drawback Schemes
  • Notwithstanding the headline contraction, allocation for Assistance to Special Economic Zones and towards WTO activities are budgeted for a moderate expansion.

Table 1: Specific trade related budgetary allocation to get pruned in 2024-25

Source: Budget documents, QuantEco Research

The sharp cut in the budgetary expenditure for the Department of Commerce in 2024-25 is not surprising as it accounts for the expiry of the Interest Equalisation Scheme after Jun-24. We do not believe this to have a material repercussion as recent steps taken by the government for export promotion are still playing out (for e.g., The Foreign Trade Policy, TIES/ MAI/ RoDTEP Schemes, Common Digital Platform for Certificate of Origin, facilitation of Districts as Export Hubs, promotion of e-commerce exports, etc.). Nevertheless, if some support is warranted on account of ongoing geopolitical disruptions (persistence of Red Sea disturbance could increase cost for exporters), the government could then look at extending the same in the upcoming normal budget in Jun/Jul 2024. Alternatively, with the Foreign Trade Policy now becoming dynamic, an addendum could get included to partially mitigate the adverse cost impact of geopolitical disruptions.

Chart 3: Global merchandise trade could potentially see a mild adverse impact due to disturbance in the Red Sea route

Source: IMF PortWatch, QuantEco Research

Note: The Red Sea region is a systemically important shipping lane that facilitates about 11% of global maritime trade. The key chokepoint lies around the Bab el-Mandeb Strait area, which in turn is connected to the Suez Canal, and is an important conduit for global maritime trade, connecting regions like Asia, Middle East, West & North Africa, Europe, and US East Coast. Most vessels are currently avoiding the Bab el-Mandeb Strait and opting for the longer route via the Cape of Good Hope.

2. Outlook on monetary policy

After maintaining a pause for four consecutive monetary policy reviews between Sep-23 and Jan-24 2023, the US Federal Reserve is once again expected to maintain the fed funds rate range unchanged at 5.25-5.50% in its forthcoming policy review meeting on Mar 20, 2024.

In the month of Jan-24, market participants were expecting the Fed to deliver cumulative rate cut of 125-150 bps from the Fed in 2024. We had highlighted that this seemed aggressive given residual inflationary pressures in the US economy, which has been witnessing a slower than anticipated loss of growth momentum.

Since then, the reversal of the rate tightening cycle by the Fed has got priced out, with market participants now expecting the first rate cut in Jun-24 vs. Mar-24 earlier. With this, the cumulative Fed rate cut expectation by market participants for 2024 currently stands adjusted at 75-100 bps. We believe the pricing now appears somewhat reasonable and investors should start positioning for the easing of US rate cycle from mid-2024 onwards.

With this as a backdrop, other key central banks could also begin their rate easing cycle with a lag. In case of India, as CPI inflation starts providing durable comfort in the coming quarters, we expect the RBI to start cutting repo rate from Oct-24 onwards with scope for up to 75 bps cumulative rate cut by Mar-25.

Table 2: Market expectation for rate easing is getting aligned with Fed member’s projections

Source: Federal Reserve, Refinitiv, QuantEco Research

Note: Fed Dot Plot reflects the median expectation of rate cuts by Fed members (as of Dec-23)

3. Rupee view

After facing persistent, albeit mild depreciation pressure over five consecutive months, INR is finally trying to recoup some of its losses. It appreciated by 0.2% each in Dec-23 and Jan-24 (closing the month at 83.04) and has gained another 0.1% in the month of Feb-24 so far (currently trading close to 82.97 levels).

• We continue to believe that INR could remain supportive in Q4 FY24 on account of favorable year-end seasonality and market positioning ahead of India’s inclusion in JPM EM bond index (from Jun-24). In the last 5-months, India has received net foreign portfolio debt inflow of USD 9 bn, exceeding equity inflow of USD 2.9 bn.
• While global geopolitical risk and domestic election related uncertainties remain on the table, the tail risks have reduced significantly amidst range-bound movement in commodity prices and the state elections that on aggregate basis went in favor of the incumbent BJP government at the centre.

Although the factors for a mild near-term appreciation in INR remain in place, we believe it is unlikely to result in a durable trend due to RBI’s active intervention in the FX market (during Sep-Dec 2023, the central bank cumulatively bought and sold record high amount of USD 131 bn and USD 133 bn on gross basis respectively, even as the cumulative net intervention was at a paltry USD 1.7 bn of sold position).

Overall, we maintain our USDINR call of 82.5 by Mar-24 and 84.5-85.0 by Mar-25.

Chart 4: Post the announcement of India’s inclusion in JPM EM Bond Index in Sep-23, foreign debt inflow has picked up pace

Source: CEIC, QuantEco Research

Note: Data for February is till 21^st

4. CYTD price change in key commodity groups and shipping cost

Note: (i) Price change is between Feb 20, 2024 and Dec 31, 2023; (ii) Oil price is represented by Brent; (iii) Agriculture Items, Industrial Metals, and Precious Metals are represented by respective Bloomberg Commodity indices; (iv) rounded off figures represented.

Data: Refinitiv, QuantEco Research

With the Israel-Hamas war continuing to simmer in the backdrop, global trade is now confronting fresh concerns in the Red Sea trade route. We take a cursory look at these developments to assess the potential on India’s merchandise trade, esp. exports. This is followed by a quick assessment of US monetary policy along with the outlook on Indian rupee. 

1. Can the Red Sea disturbance lead to trade distress? 

Global supply chains have started facing disruption as maritime activity in the Red Sea region has dropped significantly following attacks by Houthis (a Yemen based rebel group, which is known to be backed by Iran, has declared its support for Hamas) on commercial vessels since the middle of Dec-23. The Red Sea region is a systemically important shipping lane that facilitates about 11% of global maritime trade volume as per the IMF. The key chokepoint lies around the Bab el-Mandeb Strait area, which in turn is connected to the Suez Canal, and is an important conduit for global maritime trade, connecting regions like Asia, Middle East, West & North Africa, Europe, and US East Coast. 

The ongoing attack by Houthis is forcing shipping vessels to divert to a much longer route around Africa’s Cape of Good Hope. As such, the daily transit trade volume in the Bab el-Mandeb Strait area has dropped by 59% (from 4990 th metric ton to 2040 th metric ton) since the attacks in Dec-23. In the meantime, the Cape of Good Hope has seen an increase in maritime activity by 38% (from 4328 th metric ton to 5964 th metric ton), which has helped to partially offset the overall drag on global maritime trade activity. 

Chart 1: Disruption in Red Sea is leading to re-routing of global maritime trade  

  Source: IMF PortWatch, QuantEco Research 

This rerouting of global maritime trade is likely to have increased transit time by 2-3 weeks, while also resulting in a price escalation (manifested in the form of higher cost for freight, insurance, etc.). 

From India’s perspective, although it’s still early to assess the situation from an economic perspective, one needs to be watchful and cautious of the emerging dynamics of the Red Sea disturbance. Nevertheless, one could monitor India’s trade with Europe and North Africa that is likely to be the most impacted from Red Sea disturbance.  

• Europe and North Africa had a share of 17.8% and 1.1% in India’s total trade during Apr-Nov FY24 respectively. India had a larger share of merchandise exports (at 22.7%) going to Europe and North Africa (1.8%) compared to merchandise imports from Europe (14.7%) and North Africa (0.6%) respectively during Apr-Nov FY24. 

• Key goods traded include Machinery items, Gems & jewellery, Mineral fuels, Chemicals, Base metals, Vehicle parts, Optical & medical items, Textiles, etc. 

Chart 2: India’s trade with Europe and North Africa would be most vulnerable to the Red Sea disturbance 

Source: CEIC, QuantEco Research 

For India, 2023 has been dismal for exporters, with cumulative exports seeing a ~5% contraction (data available until Nov-23) in value terms over 2022. A cursory glance at India’s headline export performance since 2009 reveals a higher frequency of contraction compared to the earlier period. The 15-year period between 1994-2008 saw just one year of export contraction for India. In contrast, the 15-year period between 2009-2023 saw seven episodes of contraction in India’s exports – that’s almost 47% of the time! Rise of trade protectionism and shortening of global business cycle since the 2008 Global Financial Crisis (besides one-off factors like COVID) appear to have significantly weighed on external trade sentiment.

Chart 3: Key category of traded goods vulnerable to Red Sea disturbance   

Source: CEIC, QuantEco Research 

Note:

(i) Exports and imports represent Top 10 items of India’s trade with Europe and North Africa,

(ii) Size of the    bubble denotes value of total trade

Since there is likely to be a cost escalation (which could get passed on if uncertainty persists), the overall impact will depend on price elasticity of individual traded items – in this case low margin items could be vulnerable, while items with solid demand might not feel any pinch. One also needs to consider the impact on quality degradation from delay in trade of agriculture and food related items. Further, the impact could also be felt to extent on India’s trade with US (esp. consignment directed to/from the east coast). 

2. Outlook on monetary policy  

After maintaining a pause for three consecutive monetary policy reviews between Sep-Dec 2023, the US Federal Reserve is widely expected keep fed fund rate range unchanged at 5.25-5.50% in its forthcoming policy review meeting on Jan 31, 2024. While market participants expect 125-150 bps of cumulative rate cut by the Fed before the end of 2024, recent spate of relatively strong-to-mixed economic data has pushed forward the expected timing of first rate cut from Mar-24 to May-24. 

This is somewhat in line with our expectation that the likelihood of an early reversal of the rate tightening cycle by the Fed is relatively low on account of residual inflationary pressures amidst slower than anticipated loss of growth momentum. As such, we continue to expect the Fed to start its rate cutting cycle from Jun-24 onwards. 

3. Rupee view  

After facing persistent, albeit mild depreciation pressure over five consecutive months, INR is finally trying to recoup some of its losses. It appreciated by 0.2% in Dec-23 (closing the month at 83.21) and has gained another 0.1% in the month of Jan-24 so far (currently trading close to 83.15 levels). 

• We continue to believe that INR could remain supportive in Q4 FY24 on account of favorable year-end seasonality and market positioning ahead of India’s inclusion in JPM EM bond index (from Jun-24).  
• While global geopolitical risk and domestic election related uncertainties remain on the table, the tail risks have reduced significantly amidst range-bound movement in commodity prices and the recently concluded state elections (that on aggregate basis went in favor of the incumbent BJP government at the centre). 
• Notwithstanding the gyrations in market sentiment, the expectation of interest rate easing by the US Fed remains intact. This is bound to be supportive of emerging market currencies in the near-term. 

Although the factors for a mild near-term appreciation in INR are emerging, we believe it is unlikely to result in a durable trend due to RBI’s active intervention in the FX market (during Sep-Nov 2023, the central bank cumulatively bought and sold record high amount of USD 99 bn and USD 103 bn on average gross basis respectively, even as the cumulative net intervention was at a paltry USD 3.7 bn of sold position). In addition, Fed’s rate easing cycle in 2024 would soon be followed by key central banks over the medium term, thereby reducing the current bearishness on the USD. 

Chart 4: In recent months, FX market has seen record levels of intervention from the RBI   

4. CYTD price change in key commodity groups and shipping cost

Note: (i) Price change is between Jan 22, 2024 and Dec 31, 2023; (ii) Oil price is represented by Brent; (iii) Agriculture Items, Industrial Metals, and Precious Metals are represented by respective Bloomberg Commodity indices; (iv) rounded off figures represented. 

Data: Refinitiv, QuantEco Research 

The simmering of Israel-Hamas war continues to provide sporadic jitters to world trade. With 2023 coming to an end, we offer a bird’s eye view of merchandise trade performance. This is followed by a quick assessment of US monetary policy along with the outlook on Indian rupee.

1. 2023 global merchandise: Winners and losers

World merchandise trade experienced a decline through 2023 on account of moderation in demand as well as commodity prices. As per the UNCTAD (United Nations Conference on Trade and Development), the value of world merchandise trade is estimated to contract by approximately USD 2 trillion, representing a 7.5% fall compared to 2022.

On volume basis, while the aggregate picture is less sombre (as per CPB Netherlands, global merchandise trade expanded by 0.1% between Oct-23 and Dec-22), it is predominantly being driven by China and US. In contrast, Europe has performed poorly (amidst concentration of recent geopolitical risks), while Japan has nearly struggled to maintain last year’s run rate.

Chart 1: Among key economies, Eurozone and UK seem to have borne the brunt of trade slowdown in 2023

Source: CPB Netherlands, QuantEco Research

The upcoming year offers a sliver of hope with most multilateral bodies projecting a moderate recovery in world merchandise trade – as per the WTO, volume of global merchandise trade is projected to increase by 3.3% in 2024 compared to an estimated growth of 0.8% in 2023. Having said, there are notable risks that could continue impeding recovery in world trade:

• On aggregate basis, the IMF expects World GDP growth to post a mild moderation to 2.9% from an estimated level of 3.0% in 2023. Lagged impact of tight financial conditions, simmering geopolitical risks (like the recent disturbance in the Red Sea trade route) and volatility in commodity prices could continue to provide uncertainty.
• Trade protectionism has risen sharply in 2023. The resurgence in the use of industrial policy and the urgency of meeting climate commitments are driving changes in trade policies, both in the form of tariffs and non-tariff measures.

Chart 2: Protectionism continues to rise, inflicting harm on global trade

Source: GTA, QuantEco Research

For India, 2023 has been dismal for exporters, with cumulative exports seeing a ~5% contraction (data available until Nov-23) in value terms over 2022. A cursory glance at India’s headline export performance since 2009 reveals a higher frequency of contraction compared to the earlier period. The 15-year period between 1994-2008 saw just one year of export contraction for India. In contrast, the 15-year period between 2009-2023 saw seven episodes of contraction in India’s exports – that’s almost 47% of the time! Rise of trade protectionism and shortening of global business cycle since the 2008 Global Financial Crisis (besides one-off factors like COVID) appear to have significantly weighed on external trade sentiment.

Chart 3: Frequency of India’s export contraction has increased in last few years

Source: CEIC, QuantEco Research

Looking one level beneath the surface, we find that export of Electronic Items has so far had a fantastic performance in 2023 with a robust growth of 35.3% YoY (led by telecom instruments), while the Gems & Jewellery sector, with a contraction of 19.2% YoY (primarily on account of pearls and other precious/semi-precious stones), bore the maximum brunt.

Chart 4: India’s exports in 2023: What went and down

Source: CEIC, QuantEco Research

2. Outlook on monetary policy

Along the expected lines, the US Fed maintained status quo on policy rates at its Dec-23 policy review. This marks the third consecutive meeting of no rate action by the Fed, with fed funds rate range being maintained at 5.25-5.50%. However, the highlight of the meeting was the projection of cumulative 75 bps rate cuts by the FOMC (Federal Open Market Committee) members in 2024, an upward revision from 50 bps earlier in Sep-23. This was perceived as a dovish signal by market participants, who have now started to price in 125-150 bps of cumulative rate in 2024, with 93% implied probability (derived from fed funds futures) of first rate cut in Mar-24.

We continue to believe that the likelihood of an early reversal of the rate tightening cycle by the Fed is relatively low on account of residual inflationary pressures amidst slower than anticipated loss of growth momentum. As such, we continue to expect the Fed to start its rate cutting cycle from Jun-24 onwards.

3. Rupee view

After facing persistent, albeit mild depreciation pressure over five consecutive months, INR is finally trying to recoup some of its losses. This is broadly in line with our moderately constructive call on INR (82.5 levels by Mar-24).

• The dovish Fed policy outcome in Dec-23 has fuelled risk-on sentiment, thereby putting pressure on the US dollar, while benefiting other currencies, including the INR.
• We continue to believe that INR could remain supportive in Q4 FY24 on account of favorable year-end seasonality and market positioning ahead of India’s inclusion in JPM EM bond index (from Jun-24).
• While global geopolitical risk and domestic election related uncertainties remain on the table, the tail risks have reduced significantly amidst range-bound movement in commodity prices and the recently concluded state elections (that on aggregate basis went in favor of the incumbent BJP government at the centre).

Although the factors for a mild near-term appreciation in INR is emerging, we believe it is unlikely to result in a durable trend due to RBI’s active intervention in the FX market (during Sep-Oct 2023, the central bank bought and sold record high amount of USD 32 bn and USD 33 bn on average gross basis respectively, even as net intervention averaged at a paltry USD 0.9 bn of sold position). In addition, Fed’s rate easing cycle in 2024 would soon be followed by key central banks, thereby reducing the current bearishness on the USD.

Table 1: Market participants are more gung-ho about their Fed rate cut expectations vis-à-vis the FOMC members

Note: Fed rate action has been averaged basis cumulative projection of 75 bps cut by the FOMC

Data: FOMC, Refinitiv, QuantEco Research

4. CYTD price change in key commodity groups and shipping cost

Note: (i) Price change is between Dec 22, 2023 and Dec 31, 2022; (ii) Oil price is represented by Brent; (iii) Agriculture Items, Industrial Metals, and Precious Metals are represented by respective Bloomberg Commodity indices; (iv) rounded off figures represented.

Data: Refinitiv, QuantEco Research

Even as the Israel-Hamas war continues to simmer, tail risks for global trade have not yet acquired baseline characteristics. In this issue we highlight the emergence of a silver lining for global and Indian trade, while remaining cautious of the impending wave of slowdown. This is followed by a quick assessment of US monetary policy along with the outlook on Indian rupee.

1. Global merchandise trade: Dark clouds with silver lining

The World Trade Organization downgraded its forecast for growth in volume of world merchandise trade in 2023 to 0.8% vis-à-vis its earlier estimate of 1.7% in Apr-23. Slowdown in merchandise trade appears to be broad-based, involving many countries and a wide array of goods, esp. “certain categories of manufactures such as iron and steel, office and telecom equipment, textiles, and clothing”. A notable exception is passenger vehicle segment, sales of which have surged in 2023 so far. It appears that high inflation, tight monetary policy, dollar strength, and persistent geopolitical tensions have weighed upon global trade sentiment.

Chart 1: The WTO outlines a sombre near-term outlook for global trade

Source: WTO, QuantEco Research

While the forecast for 2023 appears sombre, there is a silver lining too:

• Global supply chains have now reverted to their baseline values that existed prior to the pandemic. This suggests that supply conditions have normalised after pandemic-related disruptions over the last three years. Falling input and output prices also suggest that global inflationary pressures are waning.
• WTO’s forecast for 2024 offers hope of recovery in global trade. If the forecast for 2024 is realised, then “Asia would be the fastest growing region on both the export and import sides”.
  
  

Chart 2: Global supply chain conditions have normalized after the pandemic related disruptions

Source: WTO, QuantEco Research

From India’s export perspective, we see this translating into tapering of contractionary pressure. On 3-month rolling basis, India’s merchandise exports grew by 2.3% YoY in Oct-23, marking its first expansion in 9-months.

Chart 3: India’s merchandise exports are showing early signs of expansion

Source: CEIC, QuantEco Research

The expansion in Oct-23 appears nearly broad-based. Barring plantation products and electronic items, all other subcategories of merchandise exports have shown an improvement in momentum on 3-month average basis. Improvement in last 3-months has been led by (i) Stone, plaster, cement, etc., (ii) Ores & minerals, (iii) Petroleum products, (iv) Marine products, (v) Textiles, (vi) Plastic & rubber items, (vii) Machinery items, and (viii) Gems & jewellery.

Chart 2: Recent improvement in India’s export momentum appears almost broad-based

Note: Size of the bubble corresponds to respective share in FY23 merchandise exports

Source: CEIC, QuantEco Research

2. Outlook on monetary policy

Along expected lines, the US Fed maintained status quo on policy rates at its Nov-23 policy review. For the first time in the current tightening cycle, the FOMC skipped hiking policy rate for two consecutive meetings. Although the Fed has retained flexibility to hike one more time, recent incoming economic data from the US suggests a softening bias on both activity and prices front.

Market participants are currently attaching a peak rate hike probability of just ~14% in the Jan-24 policy review. Thereafter, market participants are attaching a rate cut probability of ~66% for Jun-24 policy review.

We concur with the consensus view and continue to expect a turn in the US monetary policy cycle by mid-2024. This should allow other central banks to follow suit, with RBI likely to opt for its first rate cut in Q2 FY25.

3. Rupee view

In line with our expectations, INR continues to trade close to its record low levels vs. the USD, accompanied by subdued volatility. Factors weighing upon INR from near term perspective:

• India’s monthly merchandise trade deficit touched a record high level of USD 31.5 bn in Oct-23.
• Foreign investment flows (both FDI and FPI) have been subdued in recent months, possibly on account of uncertainty on US rate trajectory and elevated geopolitical risks.

While this could push INR towards a fresh all-time low of close to 84 levels (vs. the USD) by Dec-23, we note that pressure for further weakness in INR could no longer be binding in the coming weeks.

Emergence of signs of softening in US economy coupled with contained impact (so far) of Israel-Hamas war bodes well for a reversal in the INR trajectory. In the absence of fresh escalation of geopolitical risks, we continue to expect INR to partially reclaim lost ground and move towards 82 levels in Mar-24 amidst favorable Q4 seasonality and anticipated USD weakness as market participants position for a pivot in US monetary policy cycle by mid-2024.

Chart 4: Dollar and crude oil have corrected sharply in last 1-month

Data: Refinitiv, QuantEco Research

4. CYTD price change in key commodity groups and shipping cost

Note: (i) Price change is between Nov-23 and Dec-22; (ii) Oil price is represented by Brent; (iii) Agriculture Items, Industrial Metals, and Precious Metals are represented by respective Bloomberg Commodity indices; (iv) rounded off figures represented.

Data: Refinitiv, QuantEco Research