Slowest growth in four decades - Capital Economics
India Economics

Slowest growth in four decades

India Economic Outlook
Written by Shilan Shah
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Strict containment measures in response to the coronavirus outbreak in India will have severe economic repercussions. We think the economy will grow by just 1% in 2020, which would be the weakest pace of annual growth in four decades. And while the RBI has emphatically responded with aggressive monetary loosening, large-scale fiscal stimulus is also needed to support the most vulnerable during the lockdown and to prevent the drastic economic slowdown from morphing into an outright contraction in annual output.

 

We have compressed this edition of the Outlook to focus it on the most timely indicators. 

  • We have compressed this edition of the Outlook to focus it on the most timely indicators.
  • Overview – Strict containment measures in response to the coronavirus outbreak in India will have severe economic repercussions. We think the economy will grow by just 1% in 2020, which would be the weakest pace of annual growth in four decades. And while the RBI has emphatically responded with aggressive monetary loosening, large-scale fiscal stimulus is also needed to support the most vulnerable during the lockdown and to prevent the drastic economic slowdown from morphing into an outright contraction in annual output.
  • Output & Activity – The coronavirus and measures to contain it will ravage the economy over the coming months. On the domestic front, household spending and investment is likely to collapse, with only a ramping up of government spending providing any support. External demand will weaken drastically too.
  • External – Foreign portfolio flows out of India’s markets have surged to almost treble the peak during the “Taper Tantrum” in 2013. Higher foreign exchange reserves and a smaller current account deficit that is comfortably financed by relatively stable inflows of FDI mean that the external position looks far more secure now. But an extended period of risk aversion could force the RBI to deploy its FX reserves, while the sudden halt in global economic activity could threaten even FDI inflows.
  • Inflation & Policy – The priority of policymakers right now should be to provide as much support to the economy as possible. The RBI has already loosened policy significantly and has left the door open for further easing. A similarly-bold fiscal response, following a spate of earlier timid measures, is now needed to prevent the dramatic economic slowdown from spiralling into something even more malignant.

Key Forecasts

Key India Forecasts

Quarterly

Annual

% y/y

(unless otherwise stated)

2019

2020

2021

Q4

Q1e

Q2f

Q3f

Q4f

Q1f

2019

2020

2021

2022

 

Output & Activity

GDP

4.7

3.0

-5.0

2.0

4.0

7.0

5.3

1.0

9.0

6.5

Household Consumption

5.9

4.0

-12.0

3.0

6.0

7.0

5.9

0.3

10.0

7.0

Government Consumption

11.8

7.0

20.0

9.0

9.0

8.0

11.7

11.5

7.0

6.0

Investment

-5.2

-6.0

-7.0

0.0

0.0

4.0

-0.3

-3.3

5.0

6.0

Exports

-5.5

-6.0

-8.0

2.0

5.0

6.0

1.5

-1.8

6.3

6.3

Imports

-11.2

-12.0

-12.0

3.0

5.0

6.0

-1.3

-4.0

7.0

7.5

External Sector (% of GDP)

Current Account (4Q Sum)

-0.9

-0.8

0.0

0.1

-0.2

-0.6

-0.9

-0.2

-1.5

-2.0

Prices

Consumer Prices

5.8

6.7

4.5

3.0

3.5

3.7

3.7

4.5

5.0

5.0

Wholesale Prices

1.1

1.7

-0.5

-0.5

1.0

1.0

1.9

0.5

1.5

4.0

Fiscal (% of GDP)

Central Government Balance1

-3.6

-3.8

-8.0

-4.0

General Government Balance1

-6.6

-6.8

-12.0

-8.0

Monetary (end period, %)

Repo Rate

5.15

4.40

4.00

4.00

4.00

4.25

5.15

4.00

4.50

5.50

Reverse Repo Rate

4.90

4.00

3.60

3.60

3.60

3.85

4.90

3.60

4.10

5.10

Cash Reserve Ratio

4.00

3.00

2.50

2.50

2.50

3.00

4.00

2.50

3.50

4.00

Markets (end period)

Sensex Equity Index

41,254

29,469

30,500

32,600

34,750

36,000

41,254

34,750

41,000

43,500

5-yr Government Bond (%)

6.46

6.20

6.00

6.00

6.00

6.25

6.46

6.00

6.50

6.50

10-yr Government Bond (%)

6.55

6.15

6.00

6.00

6.00

6.25

6.55

6.00

6.50

7.00

INR/USD

71.4

75.7

79.0

78.5

78.0

76.0

71.4

78.0

80.0

81.0

Gold ($/oz)

1,517

1,614

1,700

1,650

1,600

1,600

1,517

1,600

1,550

1,550

Brent Crude ($/pb)

66

27

30

40

45

45

66

45

55

60

Sources: Refinitiv, Bloomberg, Capital Economics; 1Fiscal years (2019 = FY18/19)


Overview

Growth to slow to four-decade low in 2020

  • The rapid spread of the coronavirus in India, and the aggressive measures to contain it, will have severe economic repercussions. We are forecasting growth of just 1% this year, the weakest pace of annual growth since 1979. And the risks are firmly on the downside.
  • The number of recorded cases of coronavirus in India is on a sharp upward trajectory (see Chart 1) and the true number of cases is likely to be higher still, given India’s limited testing capacity. (See Chart 2.) In response, the government has enacted several containment measures, most notably a three-week shutdown requiring most people to stay in their homes.
  • There is a significant probability of the lockdown being extended given the difficulty that policymakers will face in containing the virus. Social distancing isn’t an option for many in India – for example, only 16% of households have running water in their homes. (See Chart 3.) And policing activity in the enormous informal sector (see Chart 4) is virtually impossible.
  • Our base case is that the shutdown will continue in some form for three months. This will have enormous economic repercussions. Large parts of the manufacturing, construction, transport, retail, leisure and recreation sectors will grind to a halt. Other sectors will slow significantly too.
  • Compounding all of this, the failure of Yes Bank – India’s fifth largest private lender – will cause further risk aversion among banks and curtail lending if and when demand picks up. In all, we think the economy will grow by just 1% this year, the weakest annual pace of growth since 1979. (See Chart 5.)
  • With businesses set to take a pummelling and many households in India having thin savings buffers, the onus has fallen on monetary and fiscal policy to support the economy. The RBI has stepped up with hefty rate cuts and large-scale liquidity injections to help ensure financial stability. And it has left the door open for further easing.
  • By contrast, the finance ministry’s response has been timid so far. The total stimulus announced in response to the virus outbreak amounts to just 0.7% of GDP – far lower than in many other countries. (See Chart 6.) If the Finance Ministry is able to match the scale of the RBI’s response, it could help prevent the drastic economic slowdown from spiralling into an outright contraction in annual output this year.
  • That said, the risks are still firmly on the downside and the virus could prove to have more insidious and long-lasting effects.
  • For one example, the panic in global markets caused by the virus has meant that foreign portfolio flows out of India’s markets have surged to almost treble the peak during the “Taper Tantrum” in 2013, which pushed India to the brink of a balance of payments crisis. (See Chart 7.)
  • Admittedly, higher foreign exchange reserves and a smaller current account deficit (see Chart 8) that is comfortably financed by relatively stable inflows of FDI mean that the external position looks far more secure now. But an extended period of risk aversion could force the RBI to deploy its FX reserves, while the sudden halt in global economic activity could threaten even FDI inflows. This would intensify concerns over the external position and potentially prolong the domestic slowdown.

Overview Charts

Chart 1: Number of Confirmed Coronavirus Cases
in India (Latest = 1st Apr.)

Chart 2: Number of Coronavirus Tests
(Per Million People, Latest)

Chart 3: Households with Running Water
(% of Total, Latest)

Chart 4: Non-Agri Employment in Informal Sector
(% of Total, 2018)

Chart 5: GDP (% y/y)

Chart 6: Announced Fiscal Stimulus in Response to Coronavirus (% of GDP)

Chart 7: Daily Net Foreign Portfolio Inflows
(INRbn, 1m. Sum, Latest = 31st Mar.)

Chart 8: Current Account Balance (4Q Sum, % of GDP)

Sources: WHO, OurWorldInData, ILO, Refinitiv, CEIC, CE


Output & Activity

Coronavirus to take a severe economic toll

  • India’s revised national accounts data show that the recent economic slowdown started earlier and has been more severe than previously thought. (See Chart 9.) And the rapid spread of the coronavirus in India and abroad will ravage economic activity this year.
  • The compilation of activity data for March and April will be severely curtailed as the Statistics Office is only partly operational. That places extra importance on soft survey and lower-profile data to help gauge the impact of the coronavirus and containment measures. The manufacturing PMI dipped to a four-month low in March (see Chart 10), and the reading will plunge further given the lockdown was enacted at the end of the month. Since the lockdown, road congestion in Mumbai has dropped to about 10% of the level in 2019. (See Chart 11.)
  • Focussing on the expenditure side of the national accounts, household spending is set to slump. Admittedly, the collapse in global oil prices (see Chart 12) should help consumers at the margin. But any windfall is far more likely to be saved rather than spent. The lockdown means that spending on retail, restaurants, leisure, recreation, and transport will grind to a halt. Collectively, these account for 11% of GDP. (See Chart 13.) Job losses and a fall in incomes mean that spending will weaken in areas that haven’t been closed.
  • The outlook for investment is also grim as firms will remain cautious even when they reopen. Compounding the problem, a turnaround in the weakness in lending growth (see Chart 14) seems unlikely for now as the RBI’s takeover of the failing Yes Bank – India’s fifth largest private lender – has turned banks even more risk averse. Non-bank financial companies (NBFCs) aren’t faring any better. The recent market rout has caused the spread between NBFC and government bonds to widen sharply once more (see Chart 15), and higher funding costs will dampen lending.
  • The only support for domestic demand over the near term is likely to come from government expenditure. The Finance Ministry has all but abandoned its budget deficit target for this year and fiscal support for households has been ramped up, mainly through food and cash handouts. That said, the response has been timid compared to many other countries. We expect further measures to be unveiled over the coming weeks and months, including targeted support for many of the worst-affected industries.
  • The economy will receive little external support given the extremely weak global backdrop. We think the global economy will contract by nearly 3% this year, its worst performance since the Second World War.
  • Bringing all of this together, GDP growth in India is likely to slump to just 1% this year. (See Chart 16.) Our baseline assumption is that infections fall back later in the year, allowing activity to normalise. Significant policy easing as well as generous base effects will then push growth up to around 9% in 2021.
  • But the risks to our new forecasts are still firmly on the downside. If the latest measures fail to contain the virus, or if the fiscal response isn’t stepped up, annual output could contract this year. And the public health consequences of failing to limit infections would be immense.

Output & Activity Charts

Chart 9: GDP (% y/y)

Chart 10: Manufacturing PMI (Latest = March)

Chart 11: Average Road Congestion in Mumbai
(% Increase in Journey Time Compared to Off Peak)

Chart 12: Brent Crude Oil Prices
(US$pb, Latest = 1st Apr.)

Chart 13: Gross Value Added by Sector (% of GDP)

Chart 14: Bank Lending to Commercial Sector

Chart 15: Spread of AAA Rated NBFC Bond Yields Over Government Bond Yields (%-pts, Latest = 2nd Apr.)

Chart 16: Annual GDP (% y/y)

Sources: CEIC, TomTom, Refinitiv, World Bank, Capital Economics


External

External position secure but virus could have long-lasting impact

  • The Sensex has plummeted by 26% since early March as risk aversion caused by the spread of the coronavirus has roiled global financial markets. (See Chart 17.) One aspect of this for India is that foreigners have headed for the exit. In rupee terms, net portfolio outflows are now nearly thrice as large as at the peak of outflows during the Taper Tantrum in 2013, which pushed India to the brink of a balance of payments crisis. (See Chart 18.)
  • The market turmoil is less likely to trigger an external crisis this time. Our preferred measure of external vulnerability is the gross external financing requirement (GXFR). This is the sum of a country’s current account deficit and external debt maturing over the coming year.
  • Expressing the GXFR as a share of central banks’ foreign exchange reserves helps provide a sense of the extent to which domestic policymakers can compensate for lower capital flows through asset sales. On this measure, India’s GXFR is much lower now than in the past. (See Chart 19.) It is also among the lowest across EMs. (See Chart 20.) The improvement is due in large part to two factors.
  • First, India’s current account deficit is much smaller than it was during 2013. And there’s a good chance that it will swing into a rare surplus this year. (See Chart 21.) This is due to the collapse in oil prices, which is likely to cause oil imports to drop to around 2.5% of GDP this year from 4% of GDP over the past few years.
  • Second, the RBI’s rapid accumulation of FX reserves over the past few years (see Chart 22) has also contributed to the strength of India’s external position.
  • One limitation of the GFXR measure is that it tells us little about the type of capital flows that might be financing a current account deficit and external debt.
  • In this regard, an added source of comfort for India is that net FDI inflows – which tend to be long term and relatively stable – are able to fully fund the current account portion of the GXFR and remain higher than net portfolio inflows. (See Chart 23.)
  • Nevertheless, there is clearly a great deal of uncertainty over how things evolve from here. Our baseline case is that measures will succeed in halting the spread of the virus later this year. But there is no guarantee of this and aggressive containment measures will probably be less effective in India than elsewhere.
  • A longer period of market stress could lead to a quick depletion of the RBI’s FX reserves if it intervenes to defend the rupee, which has dropped to a record low. And the unprecedented halt in economic activity across the world poses a threat to exports and FDI inflows too. If FX reserves dropped and FDI inflows start to dry up over the coming months, concerns over the external position would become much more acute and potentially prolong the economic slowdown.
  • On a more positive note, the weakness in the rupee itself shouldn’t pose too many problems from a macro perspective. After all, the decline in trade-weighted terms will be mild, and India has a very low burden of FX debt (see Chart 24), meaning that currency weakness won’t exacerbate strains in the banking sector.

External Charts

Chart 17: Sensex Equity Index (Latest = 2nd Apr.)

Chart 18: Daily Net Foreign Portfolio Inflows
(INRbn, 1m. Sum, Latest = 31st Mar.)

Chart 19: GXFR (% of FX Reserves)

Chart 20: GXFR (% of FX Reserves, Latest)

Chart 21: Current Account Balance (4Q Sum, % of GDP)

Chart 22: FX Reserves (US$bn)

Chart 23: Net Capital Flows (4Q Sum, % of GDP)

Chart 24: FX Debt (% of GDP, Sep. 2019)

Sources: CEIC, Capital Economics, World Bank


Inflation and Policy

RBI steps up, finance ministry needs to do more

  • After hitting a six-year high in January, headline CPI inflation is set to drop sharply over the coming months. Favourable base effects will cause food inflation to fall (see Chart 25), and a good monsoon harvest would add to downward pressure. Meanwhile, the collapse in oil prices and in domestic demand following the outbreak of the coronavirus means the headline rate of inflation will drop back below the 4% target soon. (See Chart 26.)
  • With inflation of little concern, the priority for policymakers is to provide support for the poor, prop up the economy and ensure financial stability.
  • The RBI has emphatically stepped up its response. The repo rate has been trimmed to a record low and the rarely-adjusted cash reserve ratio has also been cut. In addition, over INR3.7trn (US$50bn) has been ploughed into the banking sector. Governor Shaktikanta Das has reiterated that “the RBI will take whatever steps are necessary to mitigate the economic impact of COVID-19”, indicating that the door remains wide open for further monetary loosening.
  • We’ve pencilled in another 40bp of cuts in the repo and reverse repo rate in Q2. (See Chart 27.) Bond yields should stay low as a result, at least for the time being. (See Chart 28.) The cash reserve ratio could also be reduced by another 50bp. Further liquidity injections are likely too if interbank rates spike once more. (See Chart 29.)
  • More important however, large-scale fiscal stimulus is needed to provide immediate support to the most vulnerable during the lockdown and to firms to keep them afloat. The Finance Ministry has so far responded with a fiscal package including food and cash handouts worth 0.7% of GDP. That is very small compared to the fiscal response of many other economies. (See Chart 30.) But having also initially rolled out relatively small steps, these economies took a second bite at the cherry and unveiled much more aggressive measures later.
  • India will need to do the same. More food handouts would tide over the most vulnerable households and boost the likelihood of containment measures being successful. A ramping up of cash handouts would mean the poorest can purchase other essential goods such as medicine over the coming months. They would also help boost spending once the virus has been contained. In the meantime, support packages for the industries most affected by the coronavirus outbreak (such as aviation) will also be needed.
  • If the Finance Ministry does not respond adequately, it risks turning the public health crisis into an economic and humanitarian crisis. We assume it will do much more. Given the scale of the loosening in other economies as well as the Finance Ministry’s response during the 2008 global financial crisis, the central budget deficit could hit 8% of GDP this year. (See Chart 31.)
  • One issue is how a larger stimulus package will be financed. Lower oil prices will help but taxes aren’t going to be raised in this environment. That means it will be largely debt financed. This would be a concern over the medium term given that debt levels in India are already high by EM standards. (See Chart 32.) But the immediate need for stimulus should take precedent.

Inflation and Policy Charts

Chart 25: Vegetables Prices and
Vegetables CPI (% y/y)

Chart 26: Consumer Prices (% y/y)

Chart 27: RBI Policy Rates (%)

Chart 28: 10-yr Government Bond Yields
(%, Latest = 2nd Apr.)

Chart 29: Interbank Rates (%, Latest = 2nd Apr.)

Chart 30: Announced Fiscal Stimulus in Response to Coronavirus (% of GDP)

Chart 31: Central Government Fiscal Deficit (% of GDP)

Chart 32: Gross Government Debt (% of GDP)

Sources: CEIC, Dept of Consumer Affairs, RBI, Finance Ministry, IMF, CE


Shilan Shah, Senior India Economist, shilan.shah@capitaleconomics.com
Darren Aw, Asia Economist, darren.aw@capitaleconomics.com
Mark Williams, Chief Asia Economist, mark.williams@capitaleconomics.com