India: Good monsoon nurtures economic green shoots
We are finally seeing some positive news in the Indian economy, but the recovery remains fragile.
Has the economic slowdown bottomed out?
A string of positive economic news in the past months (e.g. improving PMIs and balance-of-payment data) suggests that India’s economy might be on the way back. GDP grew 4.8% y-o-y at factor-cost basis in the July-September period (13Q3), compared to 4.4% in the previous quarter and 5.2% in the same quarter last year (figure 1). The economy experienced a mild recovery despite consumer and business sentiment taking another beating thanks to the depreciation of the rupee in the second quarter, triggered by the intention of the Fed to start tapering its asset purchase programme. A plentiful monsoon supported agricultural output (4.6% y-o-y, up from 2.7% in 13Q2) and the electricity sector (7.7% y-o-y, up from 3.7% in 13Q2). On the demand side, the government pushed forward with several large infrastructure projects in August. This helped fixed investment growth, although at 2.6% y-o-y it is hardly worth cheering about. Good news came from the export sector too, which benefited from the cheaper rupee. Export growth jumped 16.3% y-o-y in 13Q3, after contracting on an annual basis in the previous three quarters.
India’s economic recovery remains fragile. The Reserve Bank of India (RBI, the central bank) has recently started a tightening cycle and the government has pledged to stick to the 4.8% of GDP fiscal deficit target. While the latter is likely to overshoot the target, it suggests that they are rather serious about not going on a spending spree ahead of the parliamentary elections in May 2014. So, the RBI tightening cycle will might act as a brake on economic growth, while fiscal policy is not expected to mitigate it.
Separately, leading indicators suggest that the recovery is still in a very pre-mature stage. The manufacturing PMI increased from 49.6 in October to 51.3 in November, making it the first reading above the 50 cut-off point since July. The services PMI also improved from 47.5 in October to 48.5 in November, but stayed in the contraction territory. Finally, industrial production contracted again in October (-1.8% y-o-y), after three months of positive growth.
Monetary policy focused on inflation
Since his installation as governor of the RBI in September, Rajan has stressed the importance of controlling inflation over economic growth on several occasions. To reinforce this point of view, the RBI hiked its policy rates twice, in September and October. The wholesale price index (WPI), India’s main measure of inflation, has been on an upward trend since May and is now above RBI’s comfort level (there is no explicit target, but informally the target is around 5%) Even though much of the increase stems from higher food and fuel price inflation, Rajan is set to show his determination as a hawkish central banker in order to anchor inflation expectations. Achieving lower and more stable inflation levels is good news for the medium term outlook even if it throws sand in the wheels of the recovery in the short-term.
India is now slightly less vulnerable to tapering
Since the Fed postponed tapering in September, the rupee has recovered some ground lost between May and September. In response, the RBI reversed several exceptional measures taken over the summer to support the rupee. The risk of being affected by the actual start of tapering by the US Fed remains, but has decreased slightly. Not only because it has been priced-in to some extent by market participants, but also because the external position of India has improved over the past months. India’s current account deficit narrowed to USD 5.2bn (1.2% of GDP) in 13Q3. This is a marked improvement from 4.9% of GDP deficit in the previous quarter. The decline in the trade deficit was the main driver behind the reduction. Merchandise exports benefited from the weaker rupee and moderate global recovery, while imports contracted on the back of administrative measures to curb imports. The reduced external vulnerability makes India less susceptible to market movements. This, in turn, lowers the possibility that the RBI will need to hike policy rates to defend the currency, which could further hurt the fragile recovery.