India: 2019 Economic Outlook

We expect real economic growth to arrive at 7.2% in calendar year 2019 on the back favourable government support. After losing elections in three states in December, Modi is clearly looking for ways to tip the scales in favour of his BJP in the run-up to the general elections due in May. Apparently, the government is preparing a farm-relief package, which will bode well for growth in FY2018/2019Q3 and Q4. However, we also expect that the impact of this sugar rush will start to wane after two quarters. Second, the impact of infrastructural stimulus (the October 2017 package) on the Indian economy will start to gain traction in FY2019/2020Q2 and Q3. This will prop up the contribution of gross fixed capital formation to GDP growth. Third, given low inflation and a softening tone of the Fed there is room for accommodative monetary policy by the Reserve Bank of India (RBI). We expect the Monetary Policy Committee (MPC) to cut policy rates by 25bps in February.

It is important to keep in mind that we have pencilled in a reasonably positive outlook for the Indian economy against a backdrop of increasing internal and external risks.

Risk 1: General election

Currently, we foresee that it will be difficult for the BJP to seize a powerful majority in India’s Lower House (Lok Sabha), which means Modi’s party will have to resort to coalition-based policymaking with other members of the National Democratic Alliance (NDA) or even non-NDA parties much more than it had to during the last five years. Under this scenario, we can expect the BJP’s business-friendly reform agenda to stall and the odds of breakthroughs on land and labour market reforms will be marginal at best. These reforms are necessary to prevent a levelling off of potential growth, which explains why we expect a less profound potential growth trajectory than the IMF (Figure 1).

There is an additional risk that the general election may turn out even less favourable for the BJP than we currently expect. In that case, we will see some heavy volatility on financial markets and our calculations show that the INR might slide to levels of 74 against the USD on the back of extensive capital flight (Figure 2). These are INR levels that we saw back in 2018 during the Indian rupee crisis, but back then we felt that the rate was not in sync with fundamentals of the INR (see here). Moreover, a loss of the BJP would also have negative implications for our GDP projections, since the opposition has not shown anything close to an alternative policy agenda.

Risk 2: Rising inflation

As a second risk, we foresee a continuation of the rebound in oil prices to 68 USD/bbl and a pickup of inflation in H2 of 2019, although we expect that inflation won’t be anywhere close to a breach of the RBI’s 6% inflation target (Figure 3). As the more dovish MPC will be reluctant to intervene, we expect a gradual depreciation of the INR against the USD as well (Figure 2).

Risk 3: Disappointing fiscal metrics

In the run-up to Budget Day on 1 February, financial markets are wary of a breach of the fiscal deficit target of 3.3% for this fiscal year. In case of a major breach, bond yields might go up to 8%. The anxiety that this scenario will unfold is fuelled by the already mentioned plans of the government to launch a farm-relief package, which could significantly weigh on fiscal metrics of the central government. We expect a breach of 0.3ppts, which is limited due to two mitigating factors. First, after severe pressure on the central bank by the government last year, which resulted in the replacement of Urjit Patel as RBI governor by Shaktikanta Das, the RBI apparently is willing to transfer an interim dividend from its reserves to the government. Allegedly, the transfer will be as large as 30,000 to 40,000 crore rupees (USD 4.2bn to 5.8bn). Second, we know from previous stimulus packages that these measures do generally not fully translate in weakening government fiscal metrics, so we have to see through the election rhetoric here as well. Ultimately, we do not expect the spread over 10y US Treasuries to get much above the current 450bps anywhere before the elections.

If, however, the farm-relief package is going to be a substantial one, the odds of a sizable breach of the fiscal target becomes larger and we could even see yields surpassing the peak of 8.2% last year, which more or less brings India in line with South Africa. This obviously is not something the government should be proud of. Moreover, we also expect the current account metrics to deteriorate the next quarter (Figure 4). All in all, we are very keen on what Finance Minister Arun Jaitley has to say when he reveals the Budget on 1 February.

Risk 4: Trade war will flare up

Although the initial talks between the US and China about trade in January have started on the right footing, we expect that both countries won’t be able to forge a more structural deal. Ultimately, China will not able or willing to meet US demands to structurally reform its economy and open up sectors to foreign competition, which will be disastrous for China’s inefficient state-owned companies. In our baseline we already have incorporated a breakdown of the talks at some point and expect the current protectionist packages to remain in place and even expanded somewhat.[1] This situation is already costing India 0.6ppts of growth in total up to 2024.

However, there is a chance that tensions will escalate further and the US will impose tariffs on all bilateral trade with China. In this scenario, according to our calculations, this would cumulatively shave off another 0.9ppts of economic growth up to 2024 (Figure 5). Although these effects are still limited due to India’s vast internal market, we have to bear in mind that India is already on a downward-sloping growth trajectory and an escalation would slowdown growth to levels seen in the aftermath of demonetisation in 2017.

[1] In our base case, the US will raise tariffs from 10% to 25% on USD 200bn worth of Chinese goods, whereas China will raise tariffs by the same amount on USD 60bn worth of US exports to Chinese shores.

Risk 5: Faster than expected global slowdown

We already have pencilled in a sufficient economic slowdown in the US in 2020, which puts a brake on world trade and global growth. However, European data in the last couple of months has been weaker than anticipated and there is a risk that the US economy slows down more than expected as well. In such a scenario, India will also feel the pinch to some extent, as the economy is not completely invulnerable to shocks in the external environment.

In 2019, we expect the Indian economy to continue to be the global outperformer in terms of economic growth and have pencilled in 7.2% for this calendar year. Growth will be supported by favourable fiscal and monetary policies. Nevertheless, there are substantial downside risks to our outlook as well, such as an defeat of PM Modi’s BJP in the general elections due in May, an escalation of the trade tensions between China and the US and a more rapidly cooling down of the global economy than expected.