Indian Economy In For A Couple Of ‘Nasty Years’, Warns Fitch Chief Economist
An ongoing credit squeeze in the Indian economy, led by a shortfall of credit from non-bank lenders, could continue to hurt growth
Growth in Indian economy could slip to 5.5 percent in the current financial year, falling below the Reserve Bank of India’s already pared-down forecast of 6.1 percent, cautioned Fitch Ratings.
An ongoing credit squeeze in the Indian economy, led by a shortfall of credit from non-bank lenders, could continue to hurt growth, said Brian Coulton, chief economist at Fitch Ratings, in a conversation with BloombergQuint.
“New borrowing in India this financial year is probably going to be some 3 percentage points weaker than it was in the previous financial year. So that is going to be a real headwind for growth,” said Coulton. While the growth forecast by Fitch is below consensus, there is still a downside to that target, he added.
Apart from the availability of credit, the cost of credit, too, remains a concern despite 135 basis points in policy rate cuts so far this year.
Weak transmission of monetary policy has meant that real interest rates remain high in the Indian economy, Coulton said. “There has been an issue with the transmission mechanism of monetary policies being transmitted to interest rates in the real economy. Some of them are related to the weaknesses in the broad financial sector, including the banks, and some of it is related to subsidised deposit rate which are limiting the decline in bank funding costs.”
A recovery from these sub-par levels of growth could also be a long drawn-out affair, Coulton cautioned. Fitch expects growth in Indian economy to stay below potential at 6.2 percent in FY21 and 6.7 percent in FY22. The rating agency sees India’s long-term potential growth at 7 percent.
Watch the conversation below:
Edited excerpts of the interview:
Can you detail your view on growth in the Indian economy? You said in a recent note that growth could fall to 5.5 percent, which is well below the RBI’s forecast of 6.1 percent.
What we focused on in this report is something called a credit impulse and it really comes from the idea that it’s the flow of new borrowing that really matters for GDP. Therefore, for GDP growth, it is the change in that flow that matters.
We are seeing that the new borrowing in India this financial year is probably going to be some 3 percentage points weaker than it was in the previous financial year. So that is going to be a real headwind for growth.
Now, we’ve had a very weak number for Q2 calendar 2019 and all the indicators are pointing to the fact that the third quarter of the calendar year is not looking any better. The 5.5 percent growth number already assumes that there is a bit of pick-up later in the year. So, even though we are pretty far below consensus on growth and there might even be a downside risk to our own forecast.
So money supply to the economy is weak. Is that mostly to do with the capacity of the financial sector?
Absolutely. I think the big issue here has been in the shadow-banking sector. The non-bank financial institutions have really reined-in their credit growth because they have seen a problem with their own funding.
These institutions were particularly important for credit growth in sectors of the economy with a high multiplier to spending. So, when you look at the NBFC lending, it supported the roads and real estate sectors and that’s been important for employment. As that has been retrenched, we are seeing that those sectors of the economy have weakened.
Indicators of rural demand such as two-wheeler sales, tractor sales, where the role of the NBFCs as the marginal suppliers of credit in the last few years has actually been very powerful, have been impacted in quite a strong way.
Till last year, there was a clamour for more liquidity. That liquidity has been provided but it is still not flowing through to NBFCs. So this is more a confidence problem rather than just a liquidity availability issue?
I think it’s partly that. Obviously, when you look at credit growth, some of the outcome is because of the banks’ and NBFIs’ decisions to lend.
One thing that worries us here is that we had had a 110 basis points of interest rate cuts this financial year till August. According to the RBI, we’ve only had a 29 basis points decline on the interest rate of fresh new lending. So, there is an issue with the transmission mechanism of monetary policies being transmitted to the interest rates in the real economy.
Some of this is related to the weaknesses in financial institutions. Some of it is related to subsidised deposit rates which are limiting the decline in bank funding costs. So, all of these are creating issues as to how much of the monetary policy is flowing to the real economy.
Back home, there has been a clamor for an asset quality review or a stress test of NBFCs to reduce the information asymmetry and bring back confidence. From your experience across other markets, would something like that play an important part in breaking this cycle of risk aversion in the financial sector?
I think the financial sector is very crucial for the macro outlook in India. What we have tended to see when we’ve had problems in the financial sector, which then feed through to the real economy, it takes an awful long time to turn that around.
The responses that we see in terms of monetary policy and some injection of capital into the banks, it is not really going to turn things around very quickly. Most of the historical experience would tell you that when you’ve had a credit supply problem, growth tends to disappoint for quite a long time after that. It takes a very long time to turn this stuff around even if you adjust the issues quite quickly. We are not sure if they are being addressed that quickly, so the economy is going to grow below-trend for a good couple of years.
On the question of monetary policy transmission, there are two school of thoughts here. One is that after 135 basis points in rate cuts and limited transmission, the MPC should hold its fire. Another is that the real rate is still high and rate cuts should continue. What is your view?
Yes, I think, there is a case for more monetary easing. We will get another rate cut before the end of the year. Although headline inflation has moved back up recently, core inflation is going down.
I am sure at this stage of the cycle, when there has been a clear decline in credit growth, it’s too late to be thinking in terms of the appropriate rate in real rate terms. It needs to be seen from the confidence perspective. I think it (another rate cut) should happen; I think it will happen.
In the next two years, you see growth at 6.2 percent in FY21 and then at 6.7 percent in the following year. What will hurt growth beyond this year? Will it be domestic or global factors?
I wouldn’t put India at the top of the list of economies of the world that are most exposed to world trade. The global factors are going to be important for India, even though we are a relatively closed economy. This is more to do with the financial sector issues. It looks like we are still in a very weak environment.
We still put potential growth in India at around 7 percent, when we look at the population dynamics, the demographics, we look at the longer term productivity trends and the investment ratio. But we really think the current environment and these financial sector issues and the problem with confidence means that final demand looks very weak.
We know there has been a corporate tax cut but it’s hard to see that the firms are immediately going to respond to having more cash in their pockets by going in for more capex at this point of time in cycle.
We may have a couple of nasty years on the cyclical front in India.
How does India compare to other emerging markets in the eyes of investors?
I think I might distinguish between the long term and the short term here. In the long term, India has one of the highest growth rates in the world of any large emerging market. So, the 7 percent; that’s actually faster than China.
Long term, its still going to be a top performer amongst the bigger economies.
But in the short term, the growth that we have seen has been weak. Other countries have also seen slowing growth; China has slowed; world trade has slowed but I think it’s been a little bit more dramatic in India relative to previous expectations and I think that is a reflection of these idiosyncratic India-specific issues.
So, I think India has been an under-performer even in a weakening global and Asian context.