Halftime Report: What The Indian Economy Will Look Like Over The Next Six Months

Halfway through the financial year, the Indian economy has seen both hits and misses in equal measure. Growth has been strong and inflation modest. But the current account deficit has widened and economists are reserving judgment on whether meeting the fiscal deficit target will be a struggle. Meantime, markets, both currency, and credit have been volatile.

Will the second half of the year follow the same script? BloombergQuint looks at the outlook for key economic indicators.

Inflation: To Remain In Check

Inflation fell below 4 percent for the first time in the year in August and remained below that mark in September. Though fuel prices rose, pushing up fuel inflation, lower than expected food price inflation kept the headline numbers in check.

The Reserve Bank of India expects inflation to rise in the second half of the year to between 4.7-4.8 percent. In line with its objective to bring down inflation to the mid-point of its inflation target of 4 (+/- 2) percent, the Monetary Policy Committee changed its stance to calibrated tightening, suggesting it may hike rates for the third time this year.

However, actual inflation data has been running below economist forecasts at least since June, shows Bloomberg data.

Some economists continue to expect inflation to surprise to the downside. Soumya Kanti Ghosh, SBI’s Chief Economic Advisor, estimates inflation to fall even further to 3 percent or even less by November. This would mean that another rate hike could be “off the table” for the rest of the year, said Ghosh.

Growth: Moderation Ahead

Extending a sequential acceleration which began in the Sept. 2017 quarter, growth hit a two-year high of 8.2 percent in the April-June 2018 period. However, most economists expect that growth rates will reduce over the rest of the three quarters.

Growth in the first quarter of the year benefited from a low base. Some of this benefit will reduce in the remaining quarters. Besides, growth could moderate due to factors such as higher oil prices and weak food price inflation. Both these could impinge on urban and rural consumption demand respectively.

The sharp weakness in the rupee could also reduce aggregate demand, leading to further moderation in the growth momentum. Any deceleration in global growth could add to this.

The pick up in investment, driven by government spending, is likely to sustain. However, any momentum in private capex will be linked to the strength of domestic demand and a further improvement in capacity utilisation, which is currently at about 75 percent.

In the second half of the fiscal GDP is expected grow at 7.3-7.4 percent according to RBI estimates. For the full financial year, growth is seen at 7.4 percent. The IMF, too, estimates a growth rate of 7.3 percent for 2018 and 7.4 percent for 2019.

Current Account Deficit: Nearing The Red Line

Economists expect concerns over the widening of the current account deficit to dominate over the second half of the year.

If oil prices remain high, India’s current account deficit could hit the upper end of the expected band of 2.5-3 percent of GDP. While India has little control over global oil prices, economists are watching whether the burden of higher fuel prices, like petrol and diesel, will reduce demand. In the past, higher subsidies on oil products meant that the government’s budget absorbed a large part of the hit from increasing oil prices. This time, however, the burden is being shared by household budgets, which could lead to a quicker adjustment in demand.

Apart from oil, economists are examining the impact of a significantly weaker rupee. The Indian currency has fallen nearly 14 percent so far this year. The real effective exchange rate, however, has depreciated by a lower 5 percent.

“We find that all else being constant, a close to 12 percent depreciation in the real effective exchange rate can indeed stabilise the current account deficit,” wrote Pranjul Bhandari, chief India economist at HSBC, in a note this week.

Bhandari expects that India’s growth differential with developed economies will keep the current account deficit wide. In normal times, this would also draw in more capital flows. However, against the backdrop of rising global rates and risk aversion, capital flows may remain weak, leading to a balance of payments deficit.

“Assuming no major increase in rate-sensitive inflows, the Balance of Payment could remain in deficit, of close to 0.5 percent of GDP,” Bhandari wrote.

Portfolio outflows for the year to date stand at over Rs 90,000 crore.

Fiscal Deficit: Living In Hope

The central government, which missed its fiscal deficit target last year, has reiterated time and again that it intends to stick to the goal of 3.3 percent of GDP for the current year.

Most economists say it’s too early to judge whether the target is achievable. However, some red flags have emerged in the form of lower than expected buoyancy in GST collections. Also, divestments, which raised more than Rs 1 lakh crore for the government last year, have been slow this year.

In a report earlier this month, the economic research department of Kotak Mahindra Bank noted that a cut in expenditure may be needed in the second half of the year if the government is to meet its fiscal deficit target.

On a cash accounting basis, collections in the first half of the fiscal are likely at around Rs 90,000 crore a month, implying a required run rate of Rs 1.19 lakh crore per month in the second half, the Kotak report said. Given the tax collection data, the research house feels the fiscal deficit may settle higher than target at 3.5 percent of GDP, unless expenditure cuts are undertaken. “Without a reduction in revenue expenditure it will be difficult to stick to the budgeted GFD/GDP, which is important from a macro-prudential basis,” the research house said.

Ghosh of SBI shared that view.

Managing Currency & Credit Markets

Apart from evolving economic data, a key challenge for authorities will remain managing the currency and the credit markets.

In the currency markets, the rupee has been the worst performing currency among Asian peers so far. Not everyone is convinced the fall is done. HSBC has cut its rupee target for end of 2018 to 76 against the U.S. dollar compared with 73 earlier. It further expects the currency to weaken to 79/$ by end of 2019.

In the credit markets, concerns over the health of certain non-banking financial companies have led to tight financing conditions. While the RBI has eased systemic liquidity conditions by purchasing government bonds, the flow of liquidity remains constrained.

In a report earlier this week, rating agency Moody’s said that liquidity tightness could lead to sharply higher financing costs or even difficulty in rolling over liabilities for NBFCs because they rely heavily on market borrowings to fund asset growth.