Nomura cuts India's 2021 GDP forecast to 11.5%; sees higher inflation

Nomura GDP forcast: Repricing of emerging market (EM) risk premium, Nomura said, could expose vulnerabilities in Indonesia, India and the Philippines

The resurgence of Covid cases in India amid possibility of higher inflation as we head deeper into 2021 has led Nomura to cut the 2021 gross domestic product (GDP) forecast for India to 11.5 per cent from the earlier 12.4 per cent. Besides India, it has cut the 2021 GDP forecast for the Philippines to 5.4 per cent from 8.8 per cent.

Repricing of emerging market (EM) risk premium, Nomura said, could expose vulnerabilities in Indonesia, India and the Philippines. The challenge for EM Asia going forward, according to them, is that these countries may face tighter financial conditions even when outlook for growth is still weak. This, it believes, will require central banks to choose between supporting growth (tolerating higher inflation) or respond via rate hikes (at the cost of growth).

“In our judgment, all three will respond (via rate hikes), but to varying degrees. A more forceful response in the Philippines and Indonesia could undermine growth, whereas a less aggressive response in India could fan inflation,” wrote analysts at Nomura in an April 9 report led by Sonal Varma, managing director and chief India economist at the research and broking house.

Counted among the ‘Fragile Five’ in 2013 in the backdrop of 'taper tantrum', India, Nomura said, has built a strong foreign currency war chest – up from 6.5 month import cover in Q1-2013 to over 17 months now. Current account balance, too, is also in a much stronger position. Despite this, the pandemic has dented the fiscal position across countries and India, Nomura believes, is at more risk of fiscal dominance.
 
“In both Indonesia and India, insufficient appetite for government bonds, relative to the large supply, has resulted in more active central bank bond buying, as they try to offset crowding out risks. Even in India and Indonesia, where we are relatively more optimistic on vaccinations, the domestic banking sector is weak and risk averse, while the full impact of the pandemic on their asset quality is unclear. With a recovery not yet secured, their domestic economies have much less capacity to handle a major shock,” Nomura said.

Despite the vaccination drives, Nomura feels India, Philippines and Indonesia will remain vulnerable to rolling pandemic waves going ahead with varying degrees of impact.

Table source: Nomura report

The Philippines, they feel, is particularly at risk as they expect only 25 per cent of the population to be vaccinated by the end of 202.

Inflation concerns

Meanwhile, those at Jefferies, too, have cautioned against the possible rise in inflation in the backdrop of firming up of key commodities. In his March 2021 note to investors, GREED & fear, Christopher Wood, global head of equity strategy at Jefferies cautioned that investors should be prepared for the biggest inflation scare since the 1980s.

In its April 7 monetary policy review, the Reserve Bank of India (RBI), however, retained its inflation forecasts for now, but cited two-way risks to the outlook. CPI inflation, as per central bank’s estimates, is expected to average 5 per cent in Q4-FY21 (January-March 2020) and 5.2-5.2 per cent in Q1-Q2 FY21-22, then fall to 4.4-5.1 per cent in Q3-Q4 FY22. This implies average annual inflation of 6.3 per cent in FY21, declining to 5 per cent in FY22.

“All considered, we expect headline inflation to remain elevated, but trend lower through 2021 and average 4.8 per cent y/y in FY21-22, which is well within the RBI’s tolerance band,” says Rahul Bajoria, chief India economist at Barclays.

Currency risk

Another key risk for India is the currency. As the EM risk gets repriced, there could be a flight of capital from the country, which will dent the rupee. This rupee weakness, Nomura said, could add to the ongoing cost-push price pressures and fan inflation. On Monday, the rupee slipped to 75.13 versus the US dollar, a level seen in August 2020.

“Like their counterparts in the rest of EM, some Asian central banks cut rates and expanded their balance sheets. Now, the spectre of US growth outperformance, the attendant rise in DM bond yields and the prospect of the US Fed tapering asset purchases sometime within the next year has triggered flashbacks to 2013 and 2018, when EM Asian central banks were forced to hike rates amid currency weakness, as investors demanded higher risk premia,” Nomura said.