Shift in the savings curve? Macro and bond implications

Suyash Choudhary

(Suyash Choudhary is Head, Fixed Income, Bandhan AMC, an asset management company)

Asset management company Bandhan AMC’s Head of Fixed Income, Suyash Choudhary, has said that 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 $6–7 billion in the 2018–20 period to $10–14 billion over the last one and a half years. The narrative on why this is happening seems to revolve around the further proliferation of global capability centres in India. In other words, we are expanding our footprint in the share of the international service industry that is now being outsourced to India.

If the rise in the services trade surplus was being offset by a similar expansion in our goods trade deficit, then this would not be of much macro-economic significance. However, that isn’t the case, as the chart below shows.

Thus, 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-term dramatic collapse in the 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 percent of GDP as opposed to 2–2.5 percent of GDP before. Admittedly, there are other sources of volatility here as well. However, the underlying trend of steady compression, led by expansion in the services trade surplus, now seems durable enough to take note of.

The macroeconomic implications

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 stable interest rates.

The services trade surplus trends discussed above can be essentially visualised as a shift rightward in the savings curve. Thus, savings have gone up at the same levels of domestic interest rates owing to additional income earned from abroad, creating those savings. This is shown in the chart below:

Ceteris paribus, this argues for stabler interest rates. And that is precisely what we have been seeing. Despite elevated levels of government borrowing and a relatively hostile external environment, local bond demand has surprised in its resilience, especially for long-term bonds.

However, for the current account trend to continue, it is essential for the government deficit to be somewhat complementary 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 increased private sector savings. 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 in 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 the maturity of new investments being made now. (IANS)