151008 india watch

Group Economics Emerging Markets

India Watch

Arjen van Dijkhuizen, +31 20 628 8052

Resilient amidst EM turmoil

08 October 2015 • • • • • •

India will surpass China as fastest growing emerging giant this year. With average wealth levels still relatively low, India can profit from catch-up gains, while an improved reform outlook and demographics are also supportive factors.

Still, growth has fallen back in Q2 and growth momentum has been hit by weaker external conditions.

External fundamentals (current account balance, FX reserves) have clearly improved since the taper tantrum in 2013.

On the back of a further drop in inflation, the Reserve Bank of India boldly cut rates more than expected in September.

All this shows India’s resilience amongst emerging markets during the recent episode of heightened market turbulence.

Also reflecting the change in our Fed call, we have become less bearish on the Indian rupee versus the US dollar.

Economic growth falls back in Q2, …

As explained in previous publications, India is set to surpass China as the fastest growing emerging giant from this year onwards, after GDP methodology revisions in mid-February lifted (estimated) growth rates by 1.5 – 2 %-points. We expect India to grow by 7.5% in 2015-16. Having said that, economic growth has lost momentum in the course of this year. Real GDP growth fell to 7% yoy in Q2 (Q1: 7.5%), driven down by industrial growth. Just as in China, the services sector is growing faster (8.6% yoy in Q2) than the industrial sector (6.4%). On the demand side, private consumption remains the key growth driver although slowing a bit in Q2. Investment growth is gradually picking up in recent quarters – in part thanks to government efforts to boost infrastructure investment –, while net exports were a small drag on growth in Q2.

Industrial production and car sales have picked up 60 50 40 30 20 10 0 -10 -20 -30

15 10 5 0 -5 -10 08

09

10 11 12 Industrial production

13

14 Car sales

India’s manufacturing PMIs outperforms in Asia index

65 60 55 50 45

% yoy

20

PMI is still above the neutral 50 mark. Still, the index fell to 51.2 in September (August: 52.3) driven down by weak external demand (the export subindex fell to a two year low of 50.4) and low prices. The Services PMI also fell back a bit, to 51.3 (August: 51.8). The composite output index fell to 51.5 (August: 52.6).

15

Source: Thomson Reuters Datastream

… with weak exports impacting on growth momentum …

Looking at the high frequency indicators, the direction for India is more positive than for most other EMs. Industrial production growth has accelerated in the course of this year, growing on average by 3.5% yoy this year compared to 1.9% in 2014. Car sales also have picked up in 2015 compared to the past few year, although slowing somewhat in recent months. Unlike many other EMs in Asia and other regions, the Manufacturing

40 08

09

10

11 India

12

13

14

15

Emerging Asia

Sources: Thomson Reuters Datastream, ABN AMRO Group Economics

… but longer-term growth prospects remain quite bright Looking over the longer term, we are of the view that India’s growth prospects remain favourable in comparison to other key emerging markets. India’s growth model is different than that of China and other east Asian countries, as it is based more on domestic demand and productivity growth (rather than being centered around public investment and exports). We have left our 2015 and 2016 growth forecasts unchanged at 7.5%, meaning that India will indeed surpass China as fastest growing emerging market this year and the next.

Several factors are supportive for India’s growth prospects.

First, PM Modi’s government –with a strong mandate in the Lower House - is the most growth oriented, business friendly one in years. Modi has made some progress with reforms in the areas of improving labor legislation and tax and subsidy systems and reducing India’s infamous red tape. Many government services are now available online and it has become much easier to start a business or get passports or

2

India Watch, Resilient amidst EM turmoil – 08 October 2015

licenses. Still, progress in sensitive areas such as land reform is stuck by India’s complex political system. Second, average wealth levels are still relatively low compared to other major EMs (in 2014, China’s GDP/capita, for instance was four times that of India). This implies that India still has quite some catching-up potential. Favourable demographics also support India’s long-term growth potential.

External fundamentals have improved since taper tantrum Global trade weakness has affected India as well. Since December 2014, export and import growth have been negative in annual terms. In the first eight months of 2015, exports contracted by 16% yoy (compared to a rise of 2.7% in the similar period last year), reflecting weak global demand and lower export prices. Imports fell by on average 12.1% yoy in 2015 so far (2014: +0.4%), partly thanks to lower commodity prices. India’s oil bill has fallen from USD 168 bn in July 2014 (12-months rolling) to USD 112 bn in August 2015. Meanwhile, the current account deficit has fallen sharply compared to the elevated levels seen in the run-up to the taper tantrum in 2015, After reaching a peak of -5% of GDP in 2012, the deficit has fallen to around 1.5% this year. For 2016, an increase to 1.8% of GDP is expected, but this remains at manageable levels.

Meanwhile, FX reserves have continued their solid rise in recent months and are expected to comfortably cover shortterm external debt almost four times and around six months of imports this year.

Current account has improved since 2012 %yoy

total of 75 bps in three separate moves. The RBI also lowered the reverse repo rate by 50 bps, to 5.75%, and took other supportive measures, such as increasing limits on foreign investment in local currency bonds. The rate cuts follow the sharp drop in inflation. CPI has fallen to a – by Indian standards – low level of 3.7% yoy in August, driven down by lower commodity prices. This is far below the RBI target of 5% by 2017. Still, the El Niño weather phenomenon might lead to some upward pressure on food prices and inflation going forward. All in all, we think the RBI will keep rates on hold for a while now.

How resilient is India now compared to 2013?

In our view, India is proving to be quite resilient to the market turmoil seen in recent months. Prudent policies, improved external finances and better growth prospects have made India less vulnerable to contagion from a Fed lift-off than it was during the taper tantrum in 2013. Back then, India was classified as one of the so-called fragile five. This increased resilience is also visible in the relative strong performance of the Indian rupee compared to other EM currencies during the recent period of heightened market turbulence. All this also explains why in our view India has ‘graduated’ from the fragile five. Hence, we have not selected India into ABN AMRO’s current fragile six (see our publication The top 6 emerging markets at risk, published last month). This is also illustrated by the improved rating prospects, with Moody’s now having a positive rating outlook compared to some negative outlooks seen during the taper tantrum.

INR bn

80

4000

60

3000

40

2000

20

1000

0

INR outperforms other ‘fragile five’ currencies EM FX per USD, index, 1 jan 2012 = 100

240 200

0

-20

-1000

-40

-2000 10

11

12

13

Current account balance (rhs)

14 Exports (lhs)

15 Imports (lhs)

160 120 80 12

Source: Thomson Reuters Datastream

RBI cuts more than expected in response to low inflation In late September, the Reserve Bank of India (RBI) joined the Asian central banks opting for further monetary easing to support growth, contrasting to central banks in other regions such as Latin America that have been forced to hike rates recently. Following central banks in China, Korea, Taiwan and Thailand, the RBI cut the main policy (repo) rate by 50 bps, to 6.75%. This was more than the 25 bp cut expected by markets (and us). Earlier this year, the RBI had cut the policy rate by a

13 Indian rupee South African rand

14 Brazilian real Turkish lira

15 Indonesian rupiah

Source: Thomson Reuters Datastream

As we have changed our view regarding the Fed lift-off, which we now expect to occur in June 2016, we have revised our USD-INR forecasts somewhat. We now expect USD-INR at 67 at end-2016 (in stead of 68). We have changed our end-2015 forecast to 65 (from 66).

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India Watch, Resilient amidst EM turmoil – 08 October 2015

Key forecasts for the economy of India 2012

2013

2014

2015e

2016e

GDP (% yoy)

5.1

6.9

7.3

7.5

7.5

CPI inflation (% yoy)

9.7

10.7

6.7

5.0

5.5

-3.0

Budget balance (% GDP)

-4.9

-4.4

-4.0

-3.5

Government debt (% GDP)

52

51

51

48

47

Current account (% GDP)

-5.0

-2.6

-1.5

-1.5

-2.0

Gross fixed investment (% GDP)

31.4

29.7

28.7

26.5

27.2

Gross national savings (% GDP)

29.1

29.6

28.9

28.7

28.5

USD/INR (eop)

54.8

61.9

63.3

65.0

67.0

EUR/INR (eop)

71.1

85.3

81.1

65.0

73.7

Budget b alance, current acc. for 2015 and 2016 are rounded figures

Source: EIU, ABN AMRO Group Economics

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