India annual outlook 2020: Slow climb to recovery


Given the nature of slowdown, India is likely to witness a slow grind towards recovery.
Radhika Rao, Philip Wee, Eugene Leow26 Nov 2019
  • Growth deceleration and financial sector stress dominated India’s narrative this year
  • Inflation is seen at below target in FY20, a shade above in FY21
  • More cuts are likely, with the RBI at the last leg of its policy easing
  • FX: INR’s depreciation bias has returned
  • Rates: Bull steepening in the INR curve is starting to look stretched
Photo credit: AFP Photo


This is an abridged version of our Thematic Report “India outlook 2020: Slow climb to recovery” (please download the pdf for the full report)

Economics

This year’s narrative on the Indian economy was dominated by a sharp deceleration in economic activity and persistent financial sector stress. Growth eased from 8% YoY in March 2018 quarter to a likely sub-5% in 3Q and 4Q19. Idiosyncratic domestic factors have played a key role in pulling down growth.

This slowdown is driven by an interplay of factors. This is part cyclical and part structural, which points to the likelihood of a slow climb to recovery in 2020. Cyclical concerns are underscored by the tight financial conditions despite an aggressive rate easing cycle this year. Liquidity premia, credit risk premia as well as term premia (spreads between Repo rate and 10Y GSec is at a multi-year high of 140bp) are elevated, hindering efficient policy transmission. 

Outlook. Our GDP Nowcast model suggests growth ended 2019 on a somber note. With more high-frequency indicators surprising on the downside, we dial down our FY20 real GDP growth to 5% YoY (prev 5.5%), with the likelihood of two quarters of sub-5% growth and inching up past 5% in 1H20. Favourable base effects, easier monetary conditions could support demand and while global conditions stabilize at lows. FY21 GDP growth is pegged at 5.8% YoY. Demand-supportive measures are expected in February’s Budget, which should help growth in the short-term. Resumption of government spending coupled by inventory restocking is expected to help production, while non-financial sectors underpin services output.

We remain hopeful of three-pronged support – monetary, fiscal and macro policies

Firstly, monetary policy. Rate cuts were the key source of policy support in 2019 with a cumulative 135bps cuts, most in the region and taking the repo rate to 5.15%. Firming up of recent inflation numbers does put the central bank in a bind.

While we are at the last leg of easing, one needs to be mindful of: a) unlike past episodes where supply shocks could lead to generalized price pressures, the present phase of weak consumption and soft confidence surveys lower the risks of a broader pickup in prices. This could give policymakers the confidence to ease without worrying over broader rise in inflation; b) full-year inflation is still running close but below the 4% target.

A pause at this juncture could reverse part of the transmission that has occurred through the bond markets, making it an uphill task to convince banks/ markets to pass on previous rate cuts. With the output gap in negative, dovish policy will stay its course. We hold out for another 50bps of cuts in FY20, divided between December 2019 and March 2020 quarters.

Next is fiscal policy. Since the government signaled fiscal consolidation in the full-year FY20 Budget in FY20, growth conditions have deteriorated. Weak growth has impacted revenue growth, compounding worries over an already weaker run-rate for tax revenues. As it stands, the evolving fiscal math points to an at least 0.2-0.3% of GDP miss in the FY20 deficit target. Nominal GDP is also below the assumed 12% YoY this year. We expect the FY20 fiscal deficit to be revised to -3.6% of GDP vs budgeted -3.3%. For FY21, February 2020 Budget assumes importance. Given weak growth dynamics, some extent of slippage in FY21 might be backed by the FRBM escape clause.

Lastly, macro policies will also be important to draw in foreign capital – investments and portfolio flows. Work on improving hard and soft infrastructure, expediting dispute resolution, clarity on contractual obligations etc. will be important aspects for investors. Year-to-date equity and debt FPIs total USD10bn, vs net outflows last year. Assuming a conducive global environment amid flush liquidity and yield-hungry investors, we expect FY21 portfolio flows to also stay supportive.

Political stability and reform agenda. Following big-ticket reforms in the first term, we expect smoothening its implementation to be in focus in the first part of the government’s second term, including simplifying the GST mechanism, strengthening the banking/ non-bank sector and tightening the bankruptcy law. Near-term priority would be to shore up growth, initially by boosting demand by fiscal means and thereafter by addressing structural constraints. In 2H19, a sharp cut in corporate tax several piecemeal sectoral measures, were the highlights. The May 2019 elections saw the ruling party extend its support base in the Lower House. The Upper house math is also expected to shift in favour of the ruling coalition over 2020 and 2021, strengthening the coalition’s political foothold.

External balances. Current account dynamics are favourable. Trade deficits have narrowed in the past three months as lackluster exports are accompanied by sharp slowdown in non-oil, non-gold imports demand; latter reflecting weak investment and consumption demand locally. We expect FY20 current account deficit to narrow to -1.4% of GDP this year and -1.8% in FY21, keeping within the comfortable threshold of sub-2%, assuming steady oil prices.

External vulnerability indicators are on the mend, helped by the central bank’s reserves accumulation. Total reserves stood at a record high of USD440bn by late-October, with imports coverage at a healthy 11x months. Total external debt has risen to a record high of USD557bn due to a sharp increase in external commercial borrowings. While long-term external debt is nearly equal to the total FX reserves, the closely watched short-term debt (due within a year) is at 0.3x of the reserves stock. On residual maturity basis (i.e. portion of total debt that is due within the year), short-term debt makes about 56% of total reserves as of June 2019 vs 57% in March 2019.

Based on our analysis of the gross external financing requirement ratio (short term debt plus current account vs reserves), India besides Indonesia, remain exposed to stress if funding conditions unexpectedly tighten in 2020.

FX: INR’s depreciation bias has returned

Look for the Indian rupee to hold a 68.5-74.5 range with a weak bias. The Reserve Bank of India is expected to further lower rates by another 50bps by March 2020 after the total 110bps delivered since February. Conversely, the Fed is likely to have completed its mid-adjustment cycle after its third cut in October.

Rates: Steepening into flattening

India govvies will hold up relatively well in early 2020 but are somewhat concerned about fiscal issues over a longer horizon. The Reserve Bank of India (RBI) has been on an aggressive easing spree but we suspect that room to cut rates has become more limited into FY21. As such, the bull steepening in the INR curve is starting to look stretched. Thus far, longer-term rates have borne the brunt of budgetary worries. Shorter-term rates have done well as low inflation is supportive of easy monetary policy. However, these dynamics could change over the coming quarters.


To read the full report, click here to Download the PDF.

Radhika Rao

Economist – India, Thailand & Eurozone
radhikarao@dbs.com

Philip Wee

FX Strategist - G3 & Asia
philipwee@dbs.com


Eugene Leow

Rates Strategist - G3 & Asia
eugeneleow@dbs.com

 

The information herein is published by DBS Bank Ltd and PT Bank DBS Indonesia (collectively, the “DBS Group”). It is based on information obtained from sources believed to be reliable, but the Group does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation & the particular needs of any specific addressee. The information herein is published for the information of addressees only & is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Group, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Group or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Group & its associates, their directors, officers and/or employees may have positions or other interests in, & may effect transactions in securities mentioned herein & may also perform or seek to perform broking, investment banking & other banking or finan­cial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Sources for all charts & tables are CEIC & Bloomberg unless otherwise specified.

DBS Bank Ltd., 12 Marina Blvd, Marina Bay Financial Center Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E. DBS Bank Ltd., Hong Kong Branch, a company incorporated in Singapore with limited liability. 18th Floor, The Center, 99 Queen’s Road Central, Central, Hong Kong.

PT Bank DBS Indonesia, DBS Bank Tower, 33rd floor, Ciputra World 1, Jalan Prof. Dr. Satrio Kav 3-5, Jakarta, 12940, Indonesia. Tel: 62-21-2988-4000. Company Registration No. 09.03.1.64.96422