India Outlook 2019: Elephant to Lose Stamina

Lower oil prices have created a positive environment for India, but we are downbeat on the economic outlook as we expect the economy to transition from a growth sweet-spot in 2018 to a soft patch in 2019. This should help correct the macro imbalances, ease underlying inflationary pressures and open up some space for policy easing, but weak growth and political uncertainty will be a negative overhang in H1 2019. Elections in Q2 2019 should mark a turning point, as political stability and the lagged effects of lower commodity prices should enable a recovery towards end-2019.

The year of sub-7% GDP growth

India staged a strong cyclical recovery in 2018, as we anticipated, aided by a normalization from supply-chain disruptions following the implementation of the goods and services tax (GST) and the reflationary effects from remonetization. We expect GDP growth to slow to 6.6% y-o-y in 2019 from 7.4% in 2018, below consensus (7.3%), due to tighter financial conditions, a negative fiscal impulse, softer global growth and election uncertainty.

1. Financial conditions have tightened significantly

The cost of capital has risen in 2018 due to the persistent liquidity deficit and the Reserve Bank of India’s (RBI) cumulative 50bp of rate hikes. Now, the availability of credit is becoming constrained. Over the last 3-4 years, shadow banks have played an important role in credit intermediation and supporting growth against a backdrop of elevated non-performing assets among public sector banks. We estimate that the credit crunch will slow GDP growth by ~0.2-0.3 percentage points (pp) over the next year, and this would likely worsen if the liquidity crisis descends into a solvency crisis.

2. A negative fiscal impulse

Central government revenues are under strain from lower-than-budgeted GST collections, lower direct tax receipts and a potential shortfall in disinvestment proceeds. We estimate that overall revenue collections will undershoot budgeted targets by 0.5% of GDP. Moreover, with lower house elections scheduled in Q2 2019, we expect full government operations to be in limbo until the new government is in place, which would pose a drag to government spending growth in H1 2019.

3. A global slowdown

The cyclical global growth impulse appears set to become less supportive. We estimate that global GDP growth will slow in 2019, led by a slowing China and the US and euro area moderating towards their long-term trends. As cyclical impulses become less favorable, we expect exports, manufacturing and the investment cycle to weaken.

4. Election uncertainty

In H1 2019, we expect political uncertainty to compound negative effects impinging on investment – such as weak external demand and high real interest rates – and arrest private investment as businesses seek political certainty before committing to new projects. The elections held in April-May 2019 will be an important determinant of future growth and investment.

Inflation within target; rate cut in H2 2019

Headline inflation undershot RBI’s projections for a consecutive year. This reflected a growing divergence between food and core inflation. We expect headline CPI inflation to average 4% y-o-y in 2019, below consensus, and within the mandated target, due to weak demand and easing input cost pressures. Specifically, we expect weakness in domestic demand to widen the output gap which, along with easing input cost pressures such as lower oil prices, is likely to ease core inflation from close to 6% in October 2018 towards 4.5% by mid-2019. We expect food inflation to edge higher in 2019 towards 3%, but still benign by historical standards. Lower inflation in India is in line with the regional trends, where a digital technology revolution is a potential further disinflationary force.

Monetary policy to resume its dovish skew

Given our expectations of a low growth-low inflation environment, we expect the policy stance to change to ‘neutral’ in either the February or April 2019 policy reviews, thereby putting a rate cut back on the table. We believe a 2.5pp real rate spread is too high and expect a 25bp rate cut in Q3 2019, followed by unchanged policy rates through 2020, in contrast to the consensus forecast for 25-50bp of rate hikes.

External imbalances to improve at the margin

Unlike in 2018, when rising oil prices resulted in a sharp worsening of the current account deficit, we expect India’s macro imbalances to improve at the margin in 2019. Specifically, we expect a combination of lower oil prices, lagged effects from real effective exchange rate depreciation and weaker domestic demand to improve the current account deficit from 2.3% of GDP in 2018 to 1.9% of GDP in 2019.

Risks to our view

The key upside risks to our view of lower growth emanate from stronger foreign demand, sustained momentum in consumption growth, a revival in private investment and an abatement of the shadow banking liquidity crisis. On inflation, spikes in oil and food prices are the key upside risks, while downside risks mostly stem from yet another year of low food inflation.

For more insights into the Outlook for India and the rest of Asia, please read Asia in 2019: always darkest before dawn.