India in 2019: No quantum of solace

The biggest challenge for India will be to reignite domestic demand amid global weakness

The year 2018 has been a roller-coaster ride for the Indian economy. Exactly a year ago, the economy was on the cusp of a cyclical recovery after the twin shocks. Uncomfortably high demand-side inflation and rising oil prices convinced the Monetary Policy Committee (MPC) to hike policy rates twice. And only a few months ago it seemed an external sector apocalypse was just around the corner. Fast forward to today, and food inflation is negative, oil prices are down 30 per cent from their October highs, and markets are now contemplating rate cuts. To predict what 2019 holds in store, we dust off our crystal ball.

India’s outlook will partly hinge on the external backdrop. The global economy appears to be headed towards a synchronised deceleration. Led by the two largest economies, the US and China, we expect global GDP growth to slow from 3.9 per cent y-o-y in 2018 to 3.6 per cent in 2019. Economic conditions in China may deteriorate markedly in H1 2019, as internal deleveraging and trade tensions come to a head. Global monetary policy looks set to remain less accommodative as the Fed lifts policy rates twice in 2019 and due to the tapering of Fed and the European Central Bank asset purchases. Against this global backdrop, we highlight four potential trends for India. 

A year of sub-7 per cent GDP growth: The global and local backdrop suggests that growth will be India’s biggest challenge in 2019. Financial conditions will remain tight, and although the shadow banks managed to stave off recent redemption pressures, serious growth concerns remain. It is a given that accelerated balance-sheet growth rates of approximately 17 per cent are now a thing of the past, but reduced credit availability could hurt sectors they lent aggressively to, namely, commercial real estate, micro, small and medium enterprises (MSME) and auto retail. Banks are stepping in partly and are likely to garner market share, but they will be unable to fully offset the credit gap left by shadow banks, either due to an inability (capital constraints) or unwillingness (risky segments) to make the necessary loans. We estimate that the credit crunch will slow GDP growth by 0.2-0.3 percentage points in 2019. 

This of course assumes that asset quality is not jeopardised. As shadow banks cut their balance sheets, non-performing assets may rise — potentially triggering grey swan events like a property market correction, or a working capital crunch for MSMEs whose wounds from demonetisation and the GST are still fresh.

Illustration by Binay Sinha

Adding to the growth pain is the cyclical global growth impulse which appears set to become less supportive and will hurt exports, manufacturing and the investment cycle. Election uncertainty until Q2 2019 will likely temper private investment as businesses seek political certainty before committing to new projects. Also, the fiscal impulse is set to turn negative as the central government’s revenues are under strain from lower-than-budgeted GST collections and a potential shortfall in disinvestment proceeds. 

On the whole, we believe that GDP growth could slow to 6.0-6.5 per cent in H1 2019, from 7.1 per cent in Q3 (July-September) 2018, before recovering towards 7.2 per cent by Q4 2019.

Another year of benign inflation: The good news is that inflation should remain benign. In 2018, the economy faced a combination of both demand-pull (closing output gap) and supply-push (weak rupee, higher oil prices) inflationary pressures, both of which we expect will reverse.

If we are right about weaker domestic demand, then the output gap will turn negative again. Along with easing input cost pressures (lower oil prices and a stable rupee), this should moderate core inflation to about 4.5 per cent by mid-2019. Some recovery in food inflation can be expected given higher minimum support prices, but two back-to-back years of depressed food prices suggest that a mix of cyclical and structural factors are at play. Some of these structural (agriculture reforms, GST-led efficiency) as well as cyclical (low global food prices, low cost of production and weak rural demand) factors still persist, and point to benign food inflation. Overall, we estimate that headline CPI inflation will average 4 per cent in 2019, close to the RBI’s mid-point target. 

Monetary policy to resume its dovish skew: Our expectation that India is headed towards a low growth-low inflation paradigm suggests that monetary policy is set to take a dovish skew. The policy stance, currently at “calibrated tightening”, should reflect this changed reality by reverting to “neutral” in early 2019. Then, given real repo rates in excess of 2.5 pp, we believe that lower repo rates are likely. Additionally, we expect the Reserve Bank of India to relax regulatory norms for banks (making them more counter-cyclical) and become more proactive in injecting liquidity.

Elections a pivotal turning point: Macro risks for India are likely to remain high in the run-up to the elections. We expect political uncertainty to hit fever pitch in January-April, as the risk of non-Bharatiya Janata Party parties coalescing to compete against the BJP will keep investor uncertainty elevated. This could adversely affect capital inflows at a time when growth numbers also shift down. 

However, after the elections, we expect the macro environment to improve. Political stability should bode well for capital inflows and boost consumer and business confidence. Along with the lagged effects of lower oil prices on real disposable incomes, we expect a revival in domestic demand towards end-2019.

Risks to our view: We acknowledge the risks to our view. Stronger foreign demand, a revival in private investment and an early abatement of the shadow banking crisis are all positive risks. On the flip side, oil prices exiting these lows and an election that results in a hodgepodge coalition are negative risks. Still, the biggest challenge for India, in our view, will be to reignite domestic demand amid global economic weakness.

Varma is chief India economist; Nandi is India Economist for Nomura