Indian economic fundamentals have improved in recent months, with a moderation in inflation, commencement of the rate easing cycle, improving outlook for the current account deficit, commitment to fiscal prudence by the Centre and revival of previously stalled projects. While available data for manufacturing output, merchandise and services trade and the kharif harvest suggest a mild easing in economic growth in Q3FY15, a pick-up in economic growth from sub-5% levels in 2012-14 has unequivocally set in.
Following a lower than expected CPI inflation for December 2014 and a sustained global correction in crude oil prices, Reserve Bank of India (RBI) cut the repo rate by 25 bps in January 2015. A crucial factor that supported the rate cut decision was the reiteration of the central government’s commitment to meeting its FY15 fiscal deficit target. Nevertheless, concerns remain regarding the quality of fiscal consolidation in FY15, with substantial expenditure cuts required to avoid a fiscal slippage, given the low growth of tax collections and subdued disinvestment proceeds.
The phasing out of excise duty cuts at the beginning of January 2015 has led producers in certain sectors to reset prices. Based on the current sowing and rainfall pattern, it is unlikely that rabi output would offset kharif losses, exerting some pressure on food prices during the ongoing quarter. Going forward, the dynamics of the monsoon and extent of increase in MSPs of various crops in FY16 would impact food inflation.
Following the modest average rise in FY15, considerable electricity tariff increases remain a risk factor for FY16. Nevertheless, CPI inflation is expected to average 6.0% in 2015, factoring in a normal monsoon, subdued commodity and crude oil prices and some appreciation of the rupee, in line with the central bank’s medium-term target. We therefore expect the upcoming monetary policy review to have a decidedly dovish tone.
However, we do not expect another rate cut until after the Union Budget for FY16 is presented, which entails a balancing act between growth-enhancing infrastructure spending by the central government and a commitment to fiscal consolidation over the medium term. At present, we expect the policy rate to be cut by a further 50 bps in 2015.
The correction in crude oil prices is expected to manifest in an improvement in India’s current account balance, even as the subdued outlook for exports and a pickup in gold imports post the withdrawal of the 20:80 scheme remain key risks. Going forward, growth of non-oil, non-gold merchandise imports is expected to exceed that of non-oil, non-gold exports, given the expected recovery in domestic demand and sluggish outlook for global growth. However, every $1/barrel reduction in the average crude oil price would reduce India’s current account deficit by $1 billion in FY16. We expect the current account deficit to print below 1% of GDP in FY16 as compared to 1.4% of GDP in FY15, and be comfortably financed by capital inflows.
The European Central Bank’s decision to purchase 60 billion euro of bonds each month until September 2016 is likely to boost global liquidity and demand for emerging market assets. The brightening macro outlook for India is expected to attract substantial foreign flows into domestic assets in 2015.
Higher inflows would exert upward pressure on the rupee as compared to a wide basket of currencies and may dampen the competitiveness of Indian merchandise and service exports, which have already recorded a contraction in Q3FY15. Therefore, we expect RBI to continue to purchase foreign currency assets in order to prevent a sharp appreciation of the rupee.
Softening interest rates and the strong intent to support growth and commitment to reforms of the Centre are likely to keep business sentiments high. However, we expect a gradual improvement in economic activity, as corporates’ balance sheets become healthier, the land acquisition process resumes post the recent ordinance, and sector specific issues related to mining and power sectors are resolved. Moreover, the growth momentum would take a cue from the speed with which new infrastructure projects are undertaken by the government.
While recent quarterly results point towards anaemic consumer demand, urban consumption growth is could revive to an extent with the moderation in inflation and the expectation of lower interest rates. However, rural income and demand would be impacted by the magnitude of rainfall and revision in MSPs.
We expect the Indian economy to record an expansion of 5.3-5.5% in FY15 and 6.0-6.5% in FY16. Overall, while the structural drivers of the Indian growth story remain intact, the pace of improvement is likely to be gradual.
By Naresh Takkar
The author is MD & CEO, ICRA Ltd