India: Strong 2Q growth to provide room for more hikes
- India’s 2Q22 (first quarter of FY23) growth likely rose 16%yoy
- Most lead indicators were up despite the Omicron wave, also helped by base effects
- Resumption in service sector activity added to the momentum besides manufacturing
- Impact of high commodity prices and heatwave will emerge as counterweights
- Our FY23 forecast at 7%yoy will see India emerge as the fastest-growing economy in Asia this year
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GDP growth – preview
Data out in late-August is likely to see India’s 2Q22 (first quarter of FY23) GDP growth mark a strong jump from 1Q, based on most lead indicators. Base effects will also have an outsized impact, as activity in the comparative year ago period was adversely affected by onset of the Delta variant, which extracted significant economic (real GDP plunged -17% qoq nsa) and humanitarian costs. Notably, the high base of FY22 and low base of the year before has lent to significant swings in yoy growth between quarters.
The DBS GDP Nowcast model for India – which captures the trend based on statistically significant monthly data – points to double digit growth. We forecast 2Q22 (1QFY23) at 16% yoy from 4.1% in the previous quarter, better than consensus. GVA growth is seen at 14.5%.
Our weekly activity gauge has recovered sharply, marking a consistent uptrend despite the Omicron wave in early 2022. Broad-based improvement in vaccination rates and relaxation of lockdowns benefited urban consumption, particularly on the back of a resumption in service sector activity, including contact intensive entertainment venues, hospitality, domestic/ international travel, restaurants, theatres etc. Unemployment rates have returned to pre-pandemic levels, with wage growth also improving, even as the labour participation rate lags 2019 levels.
Rural consumption was mixed, especially non-farm activity which lagged the lift in urban demand. Farm incomes likely received a boost from the positive terms of trade.
Banks’ credit growth also rose in the period, whilst deposits accumulation slowed. On the fiscal math, higher spending needs from increase in subsidies, cuts in excise duties etc. were offset by higher revenue collections – direct and indirect. Government’s revenue expenditure ex interest payments rose 3.5% yoy from a fall in 1Q22 as well as comparable period year before.
On the investment end, lead indicators have been encouraging – which includes pick up in capacity utilisation rates that are back above its long-run average, coal and steel output, PMIs in expansionary terrain and higher capital goods output. Public capex is likely to be a bigger support in this cycle as private sector participation might be in the slow lane, due to rising input prices and renewed uncertainty over the global growth outlook.
Goods exports (INR terms) rose by a sharp 30%yoy in the Jun22 quarter but was outpaced by 56% rise in imports owing to higher commodity purchases, resulting in near doubling of the trade deficit. Drag from net exports is likely to be wider in the quarter. Unfavourable external environment/ exogenous forces will act as counterweights, including impact of the heatwave on farm output followed by uneven start to the monsoon, sharp rise in commodity prices impinging on corporate margins and an uncertain global environment.
In the rest of FY23, base effects will reverse from 3Q22 (2QFY23) onwards, which will take the quarter’s growth to sub-7% and moderate to sub-5% by end year. Encouragingly, commodity prices have corrected, including palm oil and crude, providing relief to the trade account, input prices and inflationary risks. We maintain our FY23 growth forecast at 7%yoy, which will see India emerge as the fastest-growing economy in Asia this year, in our coverage universe.
Strong growth to keep RBI focused on inflation
Minutes from the August policy meeting mirrored hawkish undertones of the policy decision (India policy: RBI frontloads hike, more to come) and reinforced our expectations that more hikes are in the offing. The stance of ‘withdrawal of accommodation’ suggests that benchmark rates are not yet at neutral levels, presumably one-two hikes away. Most members agreed that despite signs of a cool-off in price pressures due to correction in commodity prices, it was premature to go easy on the inflation fight given considerable uncertainties from geopolitical risks and hard landing risks in major economies. Resilience in domestic growth was a source of confidence for the members but spillover from global risks were under watch.
The MPC’s views on terminal rates falls in a broad 5.4-6.5% range, with our projection at 6.0% by Mar23. With 140bp worth tightening behind us, we look for 60bp more hikes in the repo rate within FY23. Our call is for 35bp hike in September followed by another 25bp in December to take the repo rate to 6.0%, before settling into an extended pause.
Concurrently, there was some early signs of respite on capital flows. Foreign portfolio inflows into equities returned on a strong note in Aug with YTD US$5.7bn inflows after a small turnaround in Jul. Interests into debt were more modest at $0.22bn this month.
2Q22 gross FDI flows were also supportive at $22.3bn (net $16.1bn), marginally lower than 2Q21 at $23bn (net $17.2bn). On a related note, a press report suggested that US-based Apple might manufacture iPhone14 in India, in a bid to lower dependence on mainland China for its production needs as well as shorten the lag in manufacturing handsets, marking a boost to the economy’s electronics manufacturing sector as well as foreign flows. Notably Apple has already been manufacturing iPhones in India, starting with the SE mode in 2017 and iPhone13 earlier this year.
Offshore loans i.e., external commercial borrowings (ECBs) have however fallen by 25%yoy in Apr-Jun22. Tightening global liquidity and an increase in offshore borrowing costs likely impacted the appetite for external commercial borrowings after a rise in FY22, besides an under-pressure currency adding to costs. As part of steps to spur capital inflows, the ECB borrowing limit under automatic route was raised in July, which might have helped attract interest in 2QFY. Part of the financing needs might have been rechannelled to the domestic sources as bank credit growth quickened in the Jun quarter, with loans to the industry up 8.7% yoy, alongside farm and service sectors which also registered notable increases.
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