Economic growth is near its trough, rates to rise in 2014
With growth bottoming out and inflation likely to remain stubbornly high, we expect another 50bp in cumulative repo rate hikes in 2014.
We believe India’s economic growth is near its trough. Domestic demand remains very weak due to a lackluster capex cycle amid political uncertainty, falling income growth and higher interest rates. However, exports and rural demand are boosting growth. In this tug-of-war, we believe that growth has bottomed out, but the recovery will be very gradual, with GDP growth rising only marginally to 4.8% y-o-y in 2014 from 4.7% in 2013. We expect a stronger pickup in 2015, with GDP growth rising to 5.7%.
With growth bottoming out, we expect the policy focus to shift to containing inflation. We expect inflation to remain stubbornly high due to elevated inflation expectations, food-related supply shocks and the recent upswing in rural wage growth. This will require rates to remain higher for longer. We expect CPI inflation to average 9.3% in 2014, remaining above 9% for a sixth consecutive year. We expect the Reserve Bank of India (RBI) to hike the repo rate by a cumulative 50bp to 8.25% by mid-2014.
We believe India’s political climate in mid-2014 can make or break the longer-term economic outlook. In our base case, the April/May general elections usher in a stable government, which should pave the way for a more sustainable growth recovery from H2 2014 and into 2015.
Overall, we see 2014 as a year of two halves: a cautious outlook in H1 – due to weak growth, inflation concerns, political uncertainty ahead of elections and risk of capital outflows – but a more optimistic outlook in H2 (policy stability following the elections and a growth revival).
Good monsoons and better exports are likely to push GDP growth higher in Q4 2013. However, we believe that this increase is not sustainable. First, the boost from good monsoons will fade after Q1 2014. Second, the government’s fiscal finances remain under pressure, and sticking to the budget deficit target necessitates spending cuts and/or delayed payments to government contractors. Therefore, we expect fiscal policies to become contractionary in H1 2014.
Third, the cost of borrowing has risen significantly in H2 2013, which should weigh on demand in interest rate sensitive sectors with a lag. Fourth, a pickup in the investment cycle is key to a sustainable growth recovery, and uncertainty ahead of the elections means that firms will delay capex decisions until the political verdict is clear. Leading indicators continue to fall and the investment pipeline remains lackluster. Thus, after an optimistic end to 2013, we expect the growth momentum to weaken again in the first half of 2014.
Additionally, we expect inflation to remain elevated. Food inflation should moderate due to a mean-reversion in vegetable prices, but the structural uptrend in food inflation since 2008-09 remains intact due to supply-side constraints. Rural wages in India are indexed to CPI inflation and the recent spurt in inflation will raise rural wages in coming months. Higher rural wages amid elevated inflation expectations will also likely have second-round effects on core CPI inflation.
WPI inflation (largely tradables inflation) should also rise as a higher share of input costs are passed on to consumers to protect manufacturer margins, which have been under pressure (from past currency depreciation). Therefore, we expect the RBI to hike the repo rate by 25bp in each of Q1 and Q2 2014, to 8.25%.
Although external sector risks have fallen considerably, they could re-emerge early next year. India has managed to significantly lower its current account deficit due to external factors (better exports) and one-off policy restrictions (on gold imports). However, with the economy still running a deficit, capital outflows stoked by Fed tapering could put pressure the balance of payments once again. During this time, policymakers could announce India’s inclusion in global government bond indices.
Political stability and policy credibility are paramount to corporates making long-term investment decisions. India’s lower house elections are due to be held by May 2014. Nomura’s political analyst, Alastair Newton, expects a BJP-led coalition to form a government at the centre. A stable government, regardless of whether it is led by the BJP or the INC, should support a gradual business cycle recovery.
Once political stability has been established, we believe that past investment projects cleared by the Cabinet Committee of Investment (CCI) could be implemented. This revival will be led by a debottlenecking of existing investment projects. Contemporaneous with improved global demand, this should underpin a gradual economic recovery after Q3 2014. We expect GDP growth to accelerate to 5.7% in 2015 from 4.8% in 2014. Our forecast growth recovery is more gradual than India’s past cycles due to the leveraged balance sheets of corporates, higher non-performing assets on bank balance sheets and higher interest rates.
Source : moneyguruindia.com