India Sees Short-Run Risks, Long-Run Potential

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India will introduce the long-awaited national Goods and Services Tax (GST) on July 1.  Despite many unpopular decisions, Modi and his BJP remain firmly in control and this bodes well for long-run structural reforms.  However, the economy is experiencing a short-run speed bump that bears watching.


Prime Minister Modi’s BJP-led coalition remains firmly in charge.  Indeed, the BJP and its allies have done well in state elections this past year, which bodes well for the next general elections.  Why?

Modi remains popular despite making several controversial policy decisions.  His early success in cutting fuel subsidies could have spelled trouble.  So too the unexpected decision in November to demonetize the largest bills in circulation.  Yet Modi successfully pushed through a national Goods and Services Tax (GST).

The next general elections are due by mid-2019.  With the opposition remaining weak and divided, we see no credible threat to Modi then.  Congress leader Rahul Gandhi remains unpopular, and it remains to be seen if his likely replacement (and sister) Priyanka can get any more traction with voters.  Another 5-year term would allow Modi to continue with his reform agenda.

Indeed, more needs to be done with regards to structural reforms.  India scores very low in the World Bank’s Ease of Doing Business rankings (130 out of 190).  Looking at the components, India is particularly weak in dealing with construction permits and enforcing contracts.  India does relatively better in Transparency International’s Corruption Perceptions Index (79 out of 176 and tied with China and Brazil).

Indo-Pakistani relations remain tense after the recent outbreak of killings in disputed Kashmir.  Yet this is nothing new in a conflict that has been going on since independence was established for these two countries in 1946.  Unfortunately, we have come to expect periodic outbreaks of violence in Kashmir.


The economic outlook has gotten a bit cloudier.  GDP growth is forecast by the IMF to accelerate to 7.7% in FY2017/18 from 7.1% actual in FY2016/17.  Yet we note that there was a big miss for Q1 GDP earlier today, with growth of 6.1% y/y coming in a full percentage point below consensus.

It appears that the impact of the November cash ban carried over into Q1.  On the other hand, the summer monsoon season started early and bodes well for Q2/Q3 growth.  Still, Q1 GDP growth was the slowest since Q4 2014.  And with the planned implementation of the GST on July 1, we downside risks to growth ahead.

Price pressures are easing, with CPI decelerating to 3.0% y/y in April from 3.9% in March.  That was the lowest rate on record since the series started in January 2012.  This is well within the 2-6% target range and supports the case for steady rates for the time being.  WPI inflation eased to 3.85% y/y in April, down from the 5.5% peak in February.

The Reserve Bank of India next meets June 7, and no change is seen then after its surprise 25 bp reverse repo rate hike at the last meeting in April.  The GDP and inflation data argue for no move in June, as the RBI should gauge whether the slowdown carries over into Q2.  The next meeting after that is August 2, but it’s way too early to talk about that one.

Fiscal policy has remained prudent, and is likely to get a big positive shock in H2.  That’s when the long-awaited Goods and Services Tax (GST) will come into effect.  The budget deficit came in at an estimated -3.5% of GDP in FY2016/17, little changed from -3.7% in FY2015/16.  The gap is expected to narrow to -3.2% of GDP in FY2017/18 and -3.0% in FY2018/19.

The external accounts bear watching.  Low energy prices helped limit imports, but the robust economy has boosted imports.  The current account deficit was about -1% of GDP in FY2016/17, and is expected to widen to -1.3% in FY2017/18 and -1.5% in FY2018/19.

Foreign reserves rose to a record high $379 bln in May.  They cover over 8 months of import and are 1 ½ times larger than its stock of short-term external debt.


The rupee continues to perform in the middle of the EM pack.  In 2016, INR fell -2% vs. USD and was in the middle of the EM pack.  Best performers last year were BRL (+22%), RUB (+20%), and ZAR (+13%), while the worst were ARS (-18%), TRY (-17%), and MXN (-16%).  So far in 2017, INR is up 5% YTD and is still near the middle of the EM pack.  Our EM FX model shows the rupee to have STRONG fundamentals, so this year’s “so so” performance is a bit disappointing.

USD/INR has traded in a narrow 64-65 since the end of Q1.  The low near 64 recorded in late April was the lowest since August 2015.  A clean break below 64 would suggest a test of the January 2015 low near 61.30.  Retracement objectives from the 2014-2016 rise come in near 63.60 (50%) and 62.36 (62%).

Indian equities continue to underperform.  In 2016, MSCI India was -1% vs. +7% for MSCI EM.  So far this year, MSCI India is up 16% YTD and compares to 17% YTD for MSCI EM.  This underperformance should intensify, as our EM Equity model has India at a VERY UNDERWEIGHT position.

Indian bonds have underperformed recently.  The yield on 10-year local currency government bonds is +15 bp YTD.  This is ahead of only the worst performers China (+62 bp), Czech Republic (+37 bp), Romania (+20 bp), and Korea (+16 bp).  With inflation likely to remain subdued and the central bank perhaps tilting less hawkish for a period, we think Indian bonds will start to outperform more.

Our own sovereign ratings model has India’s implied rating at BBB/Baa2/BBB.  Several quarters ago, India was facing downgrade risks to its BBB-/Baa3/BBB- ratings.  Now, we are seeing some modest upgrade potential.