FMCG may not be best bet

A rising rupee may lead to consumption pullback

The rupee's fall has wider consequences than the negative impact on the current account and inflation from expensive crude and gas, and a beneficial impact on exports. In dollar terms, the equivalent of 10 per cent of national income has been wiped out in the calendar year. Calculated in current dollars, India’s Gross Domestic Product (GDP) may contract in 2018-19, assuming its growth runs at the expected 7.5 per cent and the rupee doesn't stage a big recovery. This means Indians will feel poorer, despite booming stock indices, and strong rupee-denominated growth.

  

Trade accounts for over 40 per cent of GDP with a widening trade deficit. Pretty much all imports will become more expensive. This could lead to import substitution, driving Make in India. But manufacturers will pass on higher costs as imported inputs become expensive. So there will be inflation.

India imported about $460 billion of goods last fiscal and exported about $303 billion. About 85 per cent of Indian imports (and a similar ratio of exports) are dollar-denominated.  In regional terms, 57.5 per cent of imports by value (including oil) were purchased from other Asian countries. European trade partners supplied 17.2 per cent, 7.9 per cent originated from Africa, 7.3 per cent from North America, with 4.5 per cent from Latin America and the Caribbean. 

The top ten import items accounted for 75 per cent of all imports in 2017-18. Crude and gas contributed $123 billion. Next was gold and gems at $74.4 billion. Third was electrical machinery at $46.9 billion — this includes solar equipment.  Fourth was smart phones, computers and electronic components at $36 billion. Fifth, organic chemicals $18 billion, sixth plastics, plastic articles ($13 billion), seventh was animal/vegetable fats, oils, waxes ($11.9 billion), eighth was iron, steel ($10 billion), ninth optical, technical and medical apparatus ($8.4 billion) and tenth ores, slag, ash ($5.9 billion). 

Of these, iron and steel can be substituted — there are already punitive tariffs on ferrous metal imports. There may be a fall in gold and gems imports. Gold imports in value terms are down 25 per cent in Q1, 2018-19. 

Many other items are hard to substitute. Crude and gas can't be replaced and the crude bill will rise by at least 30 per cent.  India doesn't possess scale in electronics manufacture, which means imports of phones, computers, medical equipment, chips, circuit boards, electronic components, etc., will continue. This is also true for solar components, including rare earths. 

Many imports are discretionary. If the rupee stays down, as things get more expensive, consumption would be squeezed. Households will make do with older handsets, and postpone big ticket purchases. Investment will also be squeezed. We’ve seen similar phases in earlier years when the rupee dropped, pulling down national income in dollar terms. In 2012-13, and 2013-14, when the rupee was under pressure, imports dropped a lot after peaking at $489 billion in 2011-12. Leaving crude aside, other imports saw compression.  

Consumption was a major driver in the Q1, 2018-19 results with private final consumption expenditure up by 8.6 per cent year on year, and equivalent to 55 per cent of GDP.  What's more, household consumption was driven by retail debt, with household liabilities rising to four per cent of gross national disposable income. The private investment cycle is still nascent and weak with gross fixed capital formation at 31.6 per cent of GDP, down from 32.2 per cent of GDP in Q4, 2017-18.  

When people feel poorer, they tighten belts all round. Per capita, India's imports worked out to around $360. In nominal terms, that means about 17-18 per cent of per capita income is spent on imports.  That's a big chunk. Rising import expenses will clearly hurt. We may see demand surges for inferior goods. Consumption could see a dip if the patterns of earlier years hold and the rupee stays down. This could derail expectations of strong consumption-driven growth for 2018-19. One expectation is that the economy will be flooded with black money before the elections. This may happen but it would be a very toxic ingredient coupled to already rising inflation. 

In previous periods, when the rupee fell, investors focussed on the safe havens of information technology, pharma and fast moving consumer goods. The first two sectors are surging. The third category might not be all that safe if there's a consumption pullback.