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India country primer. Bloomberg India’s steady recovery to face an election challenge Intelligence
Abhishek Gupta Economist Bloomberg Intelligence Contents
The latest 01 Growth 02 Inflation 02 Policy 03 Forecasts 04 Research 06 News
Growth & inflation 06 Supply 08 Demand 09 Inflation
Policy & structural 10 Fiscal policy 10 FX Forecast 11 Reform India country primer.
India’s steady recovery to face an election challenge (Bloomberg Intelligence) The Indian economy is returning to a slow and steady recovery. Although not evident in official year-on-year GDP data, our monthly GDP tracker adjusted for base effects shows that the recent pullback in oil prices and improving liquidity conditions are aiding growth. The new governor, Shaktikanta Das, has also turned supportive of growth, giving up his predecessor’s hawkish bias. That, along with a tailwind from structural reforms of the past few years, should support a gradual economic recovery. Still, national elections around May 2019 pose a short-term risk. Another term for Modi’s government would bode well for further reforms and market sentiment. A win for a united opposition led by the Congress and composed of smaller regional parties with different ideologies could hurt near term economic and financial stability.
The latest Growth India’s Growth Slowdown Calls for Monetary Policy Support: The downtrend in India’s GDP growth during October-December was largely driven by an unreasonably tight monetary policy and fading favorable base effects, in our view. Monetary policy has already made a U-turn under new RBI Governor Shaktikanta Das and we expect the central bank’s policies to be supportive of growth ahead. Adjusted for base effects, our monthly GDP tracker for January already shows an improvement in the pace of the recovery. GDP expanded 6.6% year on year in 3Q of fiscal 2019, below the revised down 7% reported for 2Q. For full fiscal 2019, the government lowered its second advance estimate of GDP growth to 7% from an earlier estimate of 7.2%. Looking ahead, we expect GDP growth to recover to 7.5% in fiscal 2020 from an estimated 7.1% in fiscal 2019.
GDP Growth Likely Hits Bottom, To Rebound Ahead Source: Ministry of Statistics and Programme Implementation, Bloomberg Economics India country primer. Bloomberg Intelligence
Inflation RBI Needs To Lower Rates To Lift India’s Benign Inflation: A pickup in India’s headline inflation in February should be treated with caution given it was largely driven by comparatively low food prices last year. More importantly, a marginal drop in core inflation signals that inflationary pressures may actually be easing. In our view, there’s an urgent need for a looser stance by the Reserve Bank of India to lift inflation to its target level, allowing growth to achieve the economy’s higher potential. Consumer prices rose 2.57% year on year in February, up from 1.97% in January. Core inflation eased to 5.09% from 5.14% in January. Looking ahead, we expect food prices to move out of deflation and pull up headline inflation. Even so, economic slack is likely to pull down core inflation as output growth stays below potential and input cost-price pressures remain subdued.
Inflation Remains Below RBI’s 4% Target Source: Bloomberg Economics, Reserve Bank of India
Policy India’s Central Bank Cuts, Drops Hawkish Bias — Now Data Driven: The Reserve Bank of India put to rest its hawkish bias with a rate cut in February. This change in policy course — the first with Governor Shaktikanta Das at the helm — restores growth maximization as a secondary objective of the RBI. It also signals a commitment to a symmetric policy to achieve its primary objective of 4% inflation target. That’s a departure from the RBI’s previously one-sided, conservative stance that aimed to keep inflation below target. In our view, the rate cut should stop the upward trend in deposit and lending rates, and support a gradual recovery. The monetary policy committee cut the repo rate by 25 bps to 6.25% in a 4-2 decision, but was unanimous in shifting back to a neutral stance from calibrated tightening earlier. Members Chetan Ghate and Viral Acharya voted against the rate cut.
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Forecasts India Forecast Summary: Gradual Growth Recovery Ahead We expect GDP growth to gradually recover to 7.5% in fiscal 2020 from an estimated 7.1% in fiscal 2019. Lower oil prices, improving liquidity conditions, lower bond yields and recent fiscal and monetary policy stimulus should support a cyclical recovery. Reforms in recent years are expected to provide a structural boost. We also anticipate RBI will support growth with two more 25 bp rate cuts, the first in April when we expect a shift in its stance to accommodation. The second will follow in June or August. Those two RBI rate cuts are consistent with the central bank’s primary objective of maintaining 4% inflation on a durable basis and its secondary objective of maximizing growth. In terms of the rupee, we believe the recent strength likely has some more room to run, especially if oil price stays around $65 per barrel.
India Economic Forecasts Source: Bloomberg Economics
Our view Two RBI Rate Cuts Ahead; Consensus Expects One: The consensus view among economists is for one rate cut in April, followed by a long pause. We think the consensus underestimates the need for a looser stance by the RBI to lift inflation and allow growth to catch up to the economy’s higher potential. Our prediction that the RBI would pause at its October and December policy reviews and cut rates in February proved correct. Our view is that the RBI — now on a data- dependent path — will need to lower rates further than the consensus expects. We expect the central bank to deliver two more 25 basis point reductions — the first in April. Given the easing cycle is likely to be shallow, it’s possible the RBI sticks to its neutral stance while delivering further cuts.
RBI Policy Repo Rate Forecast Source: Bloomberg Economics, Reserve Bank of India
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Research India’s Balance of Payments Swing to Surplus Lifts Rupee: India’s balance of payments is swinging into surplus, ending a three-quarter string of deficits — and helping to strengthen the rupee. The swing is being driven by an improvement in the current and the capital account balances. Lower current account deficit is largely due to a drop in crude oil prices, besides favorable trade seasonality and higher worker remittances. The return of portfolio inflows on the capital account, in our view, is likely due to an easier policy stance by the Reserve Bank of India. We estimate the balance of payments to post a surplus of $5.5 billion in 4Q fiscal 2019, shifting from an estimated deficit of $6.1 billion in fiscal 3Q. For fiscal 2020, we forecast a balance of payments surplus of $10.7 billion as our base case.
Balance of Payments to Flip to Surplus Source: Bloomberg Economics, Reserve Bank of India
India’s Modi may gain in polls on Pakistan terror stand A tough stance against a threat from Pakistan-based terrorists has won Prime Minister Narendra Modi praise from the Indian public. In our view, that could translate into electoral gains for him and his Bharatiya Janata Party in national elections in May. Political continuity would bode well for structural reforms and bolster market sentiment. The economy has achieved higher potential growth following sustained periods of structural reforms, according to our analysis. The boost to actual growth, though, only occurs after a lag. Modi’s structural reforms came at a cost of a slowdown in growth, but we expect the economy to start recovering next year. In our view, the reforms have raised India’s growth potential to 8-8.5% — and actual growth is set to catch up.
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More RBI rate cuts ahead to stoke India’s growth recovery The Reserve Bank of India needs to reduce rates further, and we expect it to move again at its April review. Inflation continuing to undershoot its target, growth below potential, and underlying price pressures set to ease all warrant more accommodation after February’s rate cut. We now expect the RBI to deliver two more 25 basis point reductions. The first will come in April, the second in June or August. The monetary policy committee, under the new leadership of governor Shaktikanta Das, is now signaling a dovish tilt for the first time since a committee structure was adopted in September 2016. That should allow the RBI to deliver more data-dependent rate cuts to support a growth recovery ahead.
MPV Turns Dovish, Sheds Hawkish Bias Source: Bloomberg Economics
India’s corporate bond sales perk up at last on RBI shift An 18-month skid in India’s corporate bond sales growth came to a halt in January, according to our tracker of outstanding issuance. Growth in bank credit, which accounts for nearly three- quarters of funding extended to firms, also picked up — boosting combined credit growth. The marginal pickup in growth of corporate bond issuance likely reflects a U-turn in the central bank’s policy away from a hawkish bias. The Reserve Bank of India started to inject more durable liquidity last November, and markets gradually started to anticipate a rate cut that the RBI delivered at its February review. This has now stalled an increase in bank deposit and lending rates, which was underway since last year.
Declining Bond Issuance Halts on Falling Rates Source: Bloomberg Economics
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Latest news on India India unveiled a populist budget in February, lining up $13 billion in giveaways by cutting taxes for the middleclass and readying cash handouts for farmers. With Prime Minister Narendra Modi facing re-election by May this year, the government decided to loosen its purse strings after running a relatively tight fiscal ship in the past four years, thus missing its budget deficit targets. The easing in fiscal policy was followed by cut in interest rates by the Reserve Bank of India which saw new Governor Shaktikanta Das chair his first monetary policy committee meeting. India’s headline inflation which has eased to a 19-month low, is expected to stay below the Reserve Bank’s medium term target of 4 percent until December this year, paving the way for more cuts as growth slows.
Growth & inflation Supply RBI Likely Underestimating India’s Potential Growth: The Reserve Bank of India’s latest outlook on growth, released in February, noted that output gap has opened up modestly as actual growth has moved below potential. That suggests RBI estimates India’s potential growth to be around 7-7.5%. In our view, structural reforms of the last few years have helped ease supply- side bottlenecks, raising potential growth to around 8-8.5%. As such, even our expected growth recovery to 7.5% in fiscal 2020 from an estimated 7.1% in fiscal 2019 is unlikely to be inflationary. The Hodrick-Prescott Filter, a widely used yardstick for estimating potential growth, suggests a pullback to 7.3% in fiscal 2019 from a peak of 7.8% in 2018. Our historical analysis shows that this methodology underestimates potential growth during periods of sustained reforms.
India’s Potential Growth May Be Underestimated Source: Bloomberg Economics
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India’s industrial sector remains weak, recovery next year India’s industrial growth recovery to an estimated 7.2% in fiscal 2019 from 6.1% in fiscal 2018 largely reflects favorable base effects. Adjusted for those, recovery remains weak. The reasons include high real interest rates in the economy, rising input costs and a liquidity crunch engineered by the central bank in late 2018. These headwinds are now reversing, especially with the Reserve Bank of India cutting rates to support growth. Looking ahead, we expect a gradual recovery to 7.8% in fiscal 2020, despite weaker global outlook projections. Subdued input cost pressures, improved liquidity and fiscal and monetary stimulus should support a cyclical recovery. We also expect a structural boost to the economy from stability in taxation and bankruptcy reforms, which were until now creating more headwinds than tailwinds.
Lower Rates To Aid Industrial Recovery Next Year Source: MoSPI, Bloomberg Economics
India’s service-sector outlook better in fiscal 2020 India’s service-sector growth is likely to recover to 8.1% in fiscal 2020, up from an estimated 7.7% in fiscal 2019. Despite favorable base effects, growth dipped marginally from 7.8% in fiscal 2018 due to multiple headwinds — higher initial goods and services tax rates, rising deposit and lending rates, constrained fiscal space due to rising oil prices, and tight liquidity conditions. The year ahead is likely to be better. Falling borrowing costs and a sharp cut in indirect tax on under-construction property is likely to boost construction activity. Government’s income support to farmers is likely to aid rural recovery and boost retail trade. Lower oil prices and an expanded budget should allow greater public spending. Finally, stronger bank balance sheets are expected to improve the credit flow to the economy.
Growth in Services Sector Source: MoSPI, Bloomberg Economics
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Demand India GDP Tracker Signals Descent Halt, Recovery Ahead: A downtrend in India’s growth ended in January in year-on-year terms, according to our monthly GDP tracker. Stripping out base effect distortions, the tracker signals the resumption of a gradual recovery that stalled in late 2018. In our view, the economy is experiencing the start of a cyclical upturn due to lower oil prices, lower bond yields, better liquidity conditions, and policy stimulus. Additionally, key reforms on bankruptcy law and indirect taxes are now stabilizing, giving a structural boost to the economy. Our monthly GDP tracker shows growth hovering at an estimated 9.4% year-on-year in January, unchanged from December. But, adjusted for base effects, the tracker shows growth picking up to 10.3% year on year in January, up from 9.7% in December and 9.4% in November.
India Bloomberg Monthly GDP Tracker Source: Bloomberg Economics
India’s rural slowdown a campaign headache for Modi India’s rural growth continued to slow in December, reflecting a terms of trade crunch for agricultural workers. Falling prices of food and a pickup in underlying input inflation add up to lower incomes and higher living costs — a painful combo for a swath of India that accounts for 45% of GDP. In response, the Modi administration has announced a new income-support package for small farmers, which is already being rolled out in select states. Rural output growth slowed to 7.3% year on year in December, down from 7.4% in November and 8% in October, according to Bloomberg Economics’ tracker. Stripping out favorable base effects, growth was even weaker. Looking ahead, a fuller roll out of the government’s income support for farmers is likely to kick start a rural recovery.
Monthly Rural Output Tracker Source: Bloomberg Economics
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Inflation Lower India Agriculture Cost Inflation Signals Oil Shock Fading: India’s agricultural input cost inflation eased to 3.6 percent year on year in January from 5.2% in December, according to our calculations. The drop in input cost inflation is in line with our expectations and likely signals a lagged impact of the recent collapse in oil prices. We expect input cost inflation to come down further in the months ahead. Lower input cost inflation bodes well for a rural recovery ahead. The rural economy is also expected to benefit from the government’s budget announcement of an income-support package for farmers.
Agriculture Input Cost Inflation Drops in January Source: MoSPI, Bloomberg Economics
India’s core-CPI inflation has starting trending down India’s core-CPI inflation, trending up last year, reversed in January 2019. A breakdown of the data shows that while rental inflation (20% weight) has been easing, inflation in goods (40% weight) and services (40% weight) has remained elevated. In our view, lower cost push pressures due to a drop in oil prices will bring those down as well, and the fall in January inflation is likely indicative of the trend ahead. India’s core-CPI inflation eased to 5.2% in January from 5.4% in December. Looking ahead, we expect further easing on increased housing supply; slack inflationary pressures due to a wider output gap, transmission of lower indirect tax rates to retail prices; and fading away of the one-off effect in December due to the change in data collection methodology in rural areas.
Core-CPI Inflation Drops in January Source: MoSPI, Bloomberg Economics
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Policy & structural Fiscal policy India’s Please-All Election Budget Comes at Cost of Capex: India’s interim budget presented on Feb. 1 marginally revised up the fiscal 2019 deficit target to 3.4% of GDP, from a budgeted target of 3.3%. It also relaxed the target for fiscal 2020 to 3.4% of GDP, from 3.1%. Fiscal slippage and the populist budget announcements — a new income-support plan for farmers and full rebate for taxpayers in the lowest taxable slab — clearly indicate that the government has moved into election mode. In our view, some of the revenue projections presented in the budget are likely to prove too optimistic, and could probably result in lower-than-budgeted capital expenditures. A larger-than-expected government gross market borrowing program for both fiscal 2019 and fiscal 2020 is likely to create upward pressure for bond yields as the market finds it difficult to absorb the increased supply.
FX Forecast 20 Indian Rupee’s Fate Tied to Oil Prices — Three Scenarios: To understand moves in India’s rupee, look at oil. After all, lower oil prices are the driving force behind the swing in the current account balance into surplus this quarter — underpinning the currency. Seasonal factors have also buoyed the rupee in recent weeks, but oil holds the key to the trend. The price of crude oil impacts the outlook of all the explanatory variables in Bloomberg Economics’ rupee forecasting model. Our base case that takes the crude price at $70/bbl suggests the rupee will be range-bound between 68-70 rupees per dollar in fiscal 2020. If oil extends its rebound to average $80/bbl, our model forecasts the rupee will weaken significantly to 71.3 rupees per dollar by March 2020. Finally, in case of weak oil at $60/bbl, the model predicts significant strength for the rupee to 66.3 levels by March 2020.
Rupee Outlook Tied to Crude Oil Price Source: Bloomberg Economics
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Seasonal support aiding Indian rupee strength India’s rupee shows a seasonal pattern of strength against the dollar from December to April each year. This is likely supporting the current strength in the rupee, which has been the best performing emerging market currency since February. The favorable seasonality is supporting the underlying strength in the rupee due to low oil prices and return of foreign portfolio inflows. Exports tend to pick up pace relative to imports during the December to April months. On average, over the past five years, the rupee has appreciated by around 1.8% during this period. The pattern reflects India’s trade cycle, as improved weather conditions drive a seasonal pickup in production and credit.
Rupee Exhibits Seasonal Strength December to April Source: Bloomberg Economics
Reform India’s Reforms Lift Growth Potential, Sustaining Output Gap: India has reduced red tape and supply bottlenecks. The Modi administration has streamlined regulations on bankruptcy and FDI, and is bringing public services online and encouraging digital transactions. A national GST has replaced a hodgepodge of levies. The government is infusing capital into public-sector banks and together with the RBI has made some headway in cleaning up banks’ bad loans. India’s ranking in the World Bank’s Doing Business report has jumped, reflecting some of these reforms. These spell accelerating potential growth. The RBI estimates potential growth at roughly 7-7.5%, against our higher estimate of around 8-8.5%. In our view, this implies that our expected growth recovery to 7.5% in fiscal 2020 from an estimated 7.1% in fiscal 2019 is unlikely to result in demand-led inflationary pressures anytime soon.
Reforms Increase India’s Growth Potential Source: Various Government of India Reports, Media Reports
To contact the analyst for this research: Abhishek Gupta at [email protected]
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