The monthly services trade surplus has been steadily rising
Suyash Choudhary,
Head, Fixed Income,
Bandhan AMC
Mumbai, November 2, 2023: Probably the most noteworthy feature of India’s recent macro-economic dynamics has been the increase in the trend rate of our services trade surplus.
The monthly services trade surplus has been steadily rising from about USD 6 – 7 billion in the 2018 – 20 period to USD 10 – 14 billion over the last one and a half years. The narrative on why this is happening seems circling around the further proliferation of global capability centers in India. In other words, we are expanding our footprint in the share of the international service industry that is now getting outsourced to India.
If the rise in services trade surplus was getting offset by a similar expansion in our goods trade deficit, then this wouldn’t be of much macro-economic significance. However, that isn’t the case.
The level of offset that the services trade surplus is providing to the goods deficit has been steadily rising (the 2020 Covid period should be ignored for the analysis owing to a short period of dramatic collapse in trade deficit). This bodes well for the overall monthly trade deficit and more generally the current account deficit, as shown below:
In the absence of commodity price shocks, India’s current account deficit trajectory now seems closer to circa 1.5% of GDP as opposed to 2 – 2.5% of GDP before. Admittedly there are other sources of volatility here as well. However, the underlying trend of steady compression, led by expansion in services trade surplus, now seems durable enough to take note of.
The Macro Economic Implication
The current account is ultimately the difference between investments (I) and savings (S) at an economy-wide level. In turn, the relative balance of S versus I is a key determinant of interest rates, ceteris paribus. Thus when I is much in excess of S (think 2013), then interest rates need to rise to reduce I and increase S. On the other hand, when the two are in better balance one can look forward to stabler interest rates.
The services trade surplus trends discussed above can be essentially visualized as a shift rightward in the savings curve. Thus, savings have gone up at the same levels as domestic interest rates owing to additional income earned from abroad creating those savings.
Ceteris paribus, argues for stabler interest rates. And that is precisely what we have been seeing. Despite elevated levels of government borrowings and a relatively hostile external environment, local bond demand has surprised in its resilience, especially that for long term bonds.
Note, however, that for the current account trend to continue it is essential for the government deficit to be somewhat complimentary to what the private sector is doing. So far there is reason to believe that this is the case. Thus, the expansion in government deficit over the past few years was on account of private sector savings having been increased. The proof of the hypothesis is in the fact that despite a higher central government fiscal deficit, the current account has broadly remained well-behaved.
If sustained, this development also has significant takeaways for bond investors. It will imply a relatively stable to possibly downward trending interest rate scenario over time, assuming no further large global shocks. Investors will have to seriously start to consider reinvestment risks on maturing investments. This is especially true as a lot of very short-term investments have been made over the past year or so considering heightened market volatility and elevated front-end rates. One way to hedge some of this risk could be to elongate maturity on new investments being made now.
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