Short Insight – India: better placed to deal with turmoil

by: Arjen van Dijkhuizen

  • With GDP growth picking up, India will become fastest growing giant again
  • Rising inflation (driven by oil, food), weaker rupee and Fed put pressure on RBI
  • Current account deficit rising again, but India not part of ‘fragile five’ anymore
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1. India set to become fastest growing giant again

We expect growth to pick up to 7.5% in the next fiscal years – supported by consumption and a pick-up in investment – and India to surpass China again as fastest growing giant. The improved reform momentum under Modi’s government, better policies, a demographic dividend and ‘catch-up effects’ are structural factors supporting growth.

More cyclically, we estimate annual growth in FY2017-18 to have dropped to 6.7%. During the calendar years 2016 and 2017, growth has slowed materially, from a stunning 9.1% yoy in Q1-2016 to a three-year low of 5.7% in Q2-17. This slowdown was aggravated by wo major events: demonetisation in late 2016 (when 90% of cash was taken out of circulation) and the introduction of the uniform Goods and Services Tax per 1 July 2017 (which in itself should be growth-positive over the longer term). With the effects of these temporary disturbances fading, GDP growth started to rise again since mid-2017, reaching 7.2% yoy in Q4-2017. We expect a similar growth rate in Q1-2018 (growth figure will be published on 31 May).

2. Higher inflation, weaker rupee and the Fed put pressure on RBI

Thanks to prudent macro economic policies and helped by falling commodity prices, CPI inflation has come down in recent years leaving the double digit levels seen during the taper tantrum in 2013 far behind. That said, since mid 2017 CPI inflation has picked up again, driven by food and energy prices and also reflecting a pick-up in domestic demand. We expect a rise to 4.5% in FY 2018-19, also reflected by rising core inflation.

Higher inflation, a weaker rupee and the Fed’s ongoing hike path is putting more pressure on the Reserve Bank of India (RBI). While we expect the RBI to remain on hold in 2018, the likelihood of an earlier rate hike has risen, certainly if we would see further pressures on the rupee and a further rise in oil prices. On the fiscal front, the budget deficit of the central government is being reduced gradually, to around 3.5% of GDP. Public debt is falling again and are at a manageable level of around 50% of GDP.

3. External deficit up again, but India not part of ‘fragile five’ anymore

The recent increase in risk aversion (with rising rates in the US and a stronger US dollar) affecting EMs is also being felt in India. Capital inflows have moderated and the rupee lost almost 5% versus USD since March. That also reflects the rising current account deficit, driven by higher oil imports. Still, at below 2.0% of GDP this deficit remains at manageable levels and is much lower than the peak of 5% GDP reached just before the taper tantrum in 2013 when India was classified as one of the ‘fragile five EMs’. Moreover, despite a recent correction (partly reflecting FX interventions), foreign reserves have risen steadily since 2013 and cover 7.5 months imports and more than 80% of foreign debt . Main external risks stem from higher oil prices, rising Fed rates and US trade measures. The US is reviewing India’s access under the preferential tariff system GSP following complaints from American firms. In March 2018, the US requested WTO dispute settlement about Indian subsidy schemes for local exporters. And in April, the US Treasury added India on its currency manipulation watchlist (this partly reflects India’s bilateral trade surplus with the US, at USD 22bn in 2017). All in all, we think that India has certainly graduated from the most fragile EMs and is much more resilient to the current market turmoil than it was in 2013.