Abhishek Gupta Economist, Bloomberg Economics
India’s macroeconomic stability - hostage to the direction of crude oil - will benefit significantly from a recent collapse in prices. The economy is likely to register improvement on all major parameters in the year ahead. We expect a steady recovery in growth, narrower current account deficit, stronger currency, and lower inflation.
These conditions would be conducive to a looser monetary policy - though our baseline scenario is for the Reserve Bank of India to remain on a long pause, given its hawkish bias. Political risks will also come to the fore with Prime Minister Narendra Modi facing elections.
We see GDP growth continuing to recover gradually in 2019, after adjusting for base effects. Structural reforms implemented by the Modi administration in the last few years have made the economy more resilient to external shocks:
GDP growth expected to recover gradually
Joint policy measures by the government and central bank are also likely to support growth and address concerns about a liquidity crunch and strict macro-prudential banking norms. On a quarterly basis, GDP growth is expected to slow until mid-2019 due to adverse base effects. Once growth starts to pick up again, though, the output gap will start closing. We forecast a 7.6% expansion in the fiscal year through March 2020, up from a forecast 7.2% in fiscal 2019 and 6.7% in fiscal 2018. We estimate potential growth at 8-8.5%.
Consumer price inflation has undershot the RBI’s 4% mid-point target for three consecutive months through October. Our inflation projections, which assume Brent will average $70 per barrel, suggest a further slowdown in the months ahead. We expect inflation to average 2.6% in 2H fiscal 2019, below the RBI’s projected 4.2% average and down sharply from an average 4.3% in 1H. Inflation in fiscal 2020 is forecast to increase to 3.6% - still a significant undershoot of the RBI’s projected range of 4.5-4.8%.
A number of factors are likely to temper inflation: the drop in crude oil prices; low food inflation due to advances in agricultural productivity; reduced indirect tax rates on goods and services; lower transportation costs due to efficiency gains in the trucking industry; and output growth that’s below potential.
RBI to bring back rate cut option
We expected slowing inflation to drive the RBI back to neutral at its upcoming policy review in December, from its current stance of calibrated tightening. Given its strong hawkish bias, our base case is for a long pause on rates through end-2019. The consensus projection is for two 25 basis point rate hikes in 2019.
Sustained weakness in oil prices would pose a risk to our baseline scenario. If Brent stays below $65/bbl, inflation would likely breach the 2% lower end of the RBI’s target range by December. In our view, that would force the RBI to deliver a rate cut at its February policy review, albeit with hawkish commentary.
Risks to financial markets
India forecast table
