2017 has turned out to be a year when many things could have gone wrong in the world economy but didn’t; we are sure investors are pleasantly surprised by that. We began the year fearful of a sustained slowdown in China, rising trade protectionism, political developments that could put the European Union fabric under strain, and the possibility of a wage-price spiral in the United States. In the event, China did not slow, protectionism did not spike, EU did not fragment, and the U.S. set up nothing short of a ‘Goldilocks’ backdrop of strong growth and muted inflation. The markets, at or near their peak worldwide, have much to be thankful for as the year comes to an end.
Asia’s open, electronics exports-oriented economies have delivered a string of strong data in recent months, allowing for several rounds of forecast upgrades. A year ago, we expected 2017 to be a broadly lackluster year, but it has turned out to be one with growth surprising on the upside and inflation remaining modest.
Except for India, all the Asian economies we track will likely beat our year-ago 2017 forecasts by 50-150 basis points.
With recent data showing sustained strength in exports and incipient signs of a pick-up in investment, we think that there is a good reason to expect a strong 2018, even without any further upside in developed economies.
China has been the key reason behind the upside surprise this year, growing at close to 7 percent when there was an expectation across-the-board of a slowdown 12 months ago. Why did China surprise on the upside? We see three broad drivers:
- First, the fiscal expansion of 2016 spilled over into this year, helping sustain demand for goods and services from the public sector. Moreover, the authorities ensured that liquidity was not taken away from the system, thus allowing for money-market stability and viability of corporates that have been facing financial difficulties. Last year’s capital account tightening measures also helped stabilise the foreign exchange market, restoring confidence and shoring up flows.
- Second, the bottoming-out of demand in the EU and a trough in the commodity market revived exports demand and investment sentiment, which helped the bottom-line of China’s exporters considerably.
- Third, while there is widespread concern about protectionism, so far there has been little friction of substance between China and the West. Consequently, Chinese consumption and investment sentiment were well-supported through the year.
China’s demand upside was complemented by a synchronised pick-up in activity in the U.S., EU, and Japan, something we have not seen in a long time. Emerging markets, in general, benefitted from this demand buoyancy; Asia, which sits at the center of global manufacturing activities, found the going particularly good as a result.
For the coming year, we have some concerns about high asset valuation and corporate debt overhang, but at the same time, we believe that the ongoing economic momentum will likely spill over to next year, keeping the data flow strong at least through the first half of 2018.
We will keep an eye on geopolitics (Europe, the Middle East, North Korea, and the U.S.), bond and credit markets (where compressed spreads look unsustainable), energy (oil could make or break the inflation outlook), commodities (a slowing China could undermine the recovery), and protectionism (watch out Canada, China, Mexico, and South Korea). Asset markets may struggle and volatility could rise, but it will take several risk events to undermine the broadening momentum in the world economy.
Cyclical forces (twin balance-sheet stress and weak trade) and structural changes (expedited formalisation) have hurt India’s growth in the past few years. Real gross domestic product growth slowed from 7.9 percent year-on-year in April-June 2016 (i.e. Q1FY17) to a three-year low of 5.7 percent in Q1FY18. In Q2, there was some stabilisation at 6.3 percent year-on-year on restocking demand and better consumption, with incoming data for Q3 looking slightly tepid.
With businesses still adjusting to the Goods and Services Tax, slow progress in corporate deleveraging, and limited room for fiscal support, our FY18 GDP forecast stands at 6.6 percent year-on-year from 7.1 percent in FY17.
We expect the economy to recover to 7.2 percent year-on-year in FY19. Consumption is expected to drive this revival as households benefit from higher wages and allowances, along with benign inflation and wide real rates. GST tweaks will help lower the tax incidence on consumers. Lead indicators, including automobile sales and personal credit growth (for urban spending), as well as non-durables output (rural demand), are expected to improve.
The capex cycle is expected to recover from the trough due to deleveraging efforts and institutional reforms, but the turnaround will be gradual amidst weak debt-servicing ability and low capacity utilisation rates. Government expenditure is likely to rise on a pre-election boost, albeit focused on fixing supply gaps (rural and infrastructure) rather than boosting demand (subsidies, handouts etc.).
Hence, we don’t expect the government to give in to outright populism, and remain on a fiscal consolidation path, even if the glide path is more gradual.
Finally, the external sector will continue to be a drag on growth owing to higher oil and non-oil imports.
The recent rating upgrade from Moody’s was a big boost to sentiment and is likely to lower offshore borrowing costs for Indian companies. But it comes at a time when risks to India’s macroeconomic environment have risen compared to the past three years. Inflation is expected to edge up on higher commodity prices and stronger demand momentum, while the current account and fiscal deficits run the risk of re-widening. These will test the economy’s resilience against any unexpected event shocks, at a time when global tailwinds (oil and liquidity) look set to reverse.
The Reserve Bank of India policy committee left benchmark rates unchanged in December, signalling the continuation of a neutral stance. An imminent shift towards a tighter policy is unlikely, but the inflationary impact of high oil prices, bank recapitalisation measures, and fiscal slippage risks are under watch.
Further upside to inflation and growth will likely nudge the RBI to turn hawkish, the likelihood of which is steadily rising.
A busy political calendar is underway; two states went to polls in November-December 2017, and more than ten state elections will be held until the results of the Lok Sabha elections are known in mid-2019. The crucial states are Rajasthan, Karnataka, and Madhya Pradesh. These states have a bigger weight in the Upper House of Parliament.
The government’s representation in the Upper House has started to tilt in its favour. The Bharatiya Janata Party increased its seats in the Upper House to 57 from 49 in May 2016. In turn, the ruling coalition’s representation rose to 86 from around 65. While this still fell short of a majority in the 245-seat Upper House, the upcoming state elections will be important for increasing its presence.
The ruling party’s performance in the 2018 state polls will serve as a litmus test of its popularity. The political narrative is likely to emphasise its fight against corruption/black money, efforts to ease the GST-driven bottlenecks (to assuage the concerns in the business/traders’ community), whilst supporting the farm and rural sector with more focused reforms. The upcoming state polls will be early indicators of the May 2019 general elections.
Taimur Baig is Chief Economist and Managing Director; and Radhika Rao is Economist at DBS Bank.
The views expressed here are those of the authors’ and do not necessarily represent the views of Bloomberg Quint or its editorial team.