RaboResearch - Economic Research

India’s economic slump: Is there worse in store or light at the end of the tunnel?

Economic Report

  • The GDP print of 5.0% for fiscal q1 2019/20 showed India’s economic activity slowing to the lowest rate in six years
  • At this point it is uncertain whether the economic slump has bottomed out.
  • From a structural perspective a rebound in growth to 6% seems likely given the substantial widening of India’s output gap
  • However, at this stage there is insufficient high-frequency data for fiscal q2 to support the case for a strong rebound
  • The key downward risks to the rebound in growth outlook are a hard Brexit, a further escalation of the trade dispute between the US and China or its extension to Europe/Japan.
  • The absence of a structural reform agenda by the government is another factor tempering optimism on India’s structural growth trajectory
  • While a substantial stimulus package would be required to lift the spirits in the Indian economy, the government has only limited options available given its unfavorable fiscal position
  • The only actor able to provide stimulus in a relatively painless way is the Indian central bank. We anticipate that the RBI will cut its policy rates by 40bps after the October MPC meeting and another 25bps in December
  • USD/INR is expected to stay at elevated levels, between 71 and 72

A bad start for the new Modi government

Prime Minister Modi started his second term amid a rocky period for the Indian economy. The GDP print for fiscal Q1 2019/20 released by the Central Statistical Office (CSO) on 30 August came in at 5% (y-o-y), which was much lower than any analyst had anticipated., Developments in the external environment have also been unfavorable, fueling a general risk-off sentiment among investors vis-à-vis emerging markets. The question is: where do we go from here? Is the slump in economic activity going to get worse in the upcoming period or do we see light at the end of the tunnel? In this Economic Report, we present a full overhaul of our forecasts of key economic indicators.[1]

Private consumption main culprit in current slowdown

With a GDP print of 5.0% for fiscal q1 2019/20, India’s economy slowed to the lowest growth rate in 6 years (fiscal q4 2012/2013 was 4.3%). A breakdown of the main expenditure components shows that lower private consumption is the main culprit behind the current economic slump (Figure 1). Private consumption contributed a meagre 1.8pptsin fiscal q1 compared to between 4 and 5ppts in the previous quarters. As private consumption is responsible for 55% of India’s GDP, a rebound in private consumption is a condition sine qua non for a recovery of the Indian economy. 

Figure 1: India’s growth slowed to lowest level in six years
Figure 1: India’s growth slowed to lowest level in six yearsSource: CSO, Macrobond, Rabobank
Figure 2: Vehicle sales contraction was out-of-sync with other indicators
Figure 2: Vehicle sales contraction was out-of-sync with other indicatorsSource: Macrobond, Rabobank

An important leading indicator of private consumption is vehicle sales, which are reported on a monthly basis (Figure 2). Vehicle sales contracted by 12% (y-o-y) in fiscal q1, which in retrospect should have been seen as a portent for that quarter’s GDP print. The fact that other important leading indicators, such as industrial production (IIP) and personal loans growth, have held up well, could explain why the weak GDP print still came as a surprise.

Has the economic slump bottomed out?

So the big question is: has the economic slump bottomed out? Our direct and honest answer to that question is: this is far from clear. As we point out later in this piece, there are considerable downside risks to begin with. However, looking at India’s prospects from a more structural angle, we note that India’s growth rate has fallen short of its long-term potential growth rate, suggesting that there is sufficient recovery potential (Figure 3). From this perspective, we feel it is unlikely that India’s economic growth will slip much further, although we are less optimistic than the IMF about India’s potential growth trajectory.

Figure 3: India has substantial recovery potential
Figure 3: India has substantial recovery potentialSource: IMF, Macrobond, CSO, Rabobank

There are several policy plans which are expected to gain traction and support growth in the second half of fiscal 2019/2020. First, the Pradhan Mantri Kisan Samman Nidhi scheme (more commonly known as the income support scheme for farmers) of INR 750bn, will improve the purchasing power of the farmer community and contribute to private consumption. Next to income support measures, we expect the 2017 infrastructural plans of INR 7000bn continue to bolster growth of gross fixed capital formation in fiscal q2 and q3, contributing respectively 3.3 and 3.7ppts to overall GDP growth. Ultimately, we have penciled in a rebound of economic growth of 6% in fiscal q2 and growth for fiscal 2019/20 as a whole to arrive at 5.9% (Figure 3).

Downside risks to revised outlook

Figure 4: Impact of US-China trade war on Indian economy
Figure 4: Impact of US-China trade war on Indian economySource: CSO, OECD, Rabobank, Macrobond

We wish to stress, though, that there are many downward risks to our revised GDP forecasts. In the revised forecasts we have taken into account the additional protectionist measures that both the US and China have announced and have partly implemented.[2] According to our calculations, the recent escalation will shave 0.2ppts off Indian economic growth in both 2019 and 2020 (Figure 4). A further escalation of the trade conflict, however, would likely put even more downward pressure on economic growth and would therefore require us to lower our forecasts.

Table 1: India ranks top 5 in the WWTG index
Table 1: India ranks top 5 in the WWTG indexSource: Rabobank

Some analysts argue that India might benefit from the US-China trade war, as several US and European companies are actively relocating production lines from China to other low-cost Asian emerging markets. Recent research by Rabobank indeed shows that India has a high position in our newly-developed Where Will They Go (WWTG) index (Table 1).[3]

Going forward, therefore, India has a good chance to attract business activities which previously took place in China. There are already some examples, such as Procon Pacific and Pegatron. However, these potential upside effects for the Indian economy could be adversely affected if President Trump takes action against Emerging Markets that appear to be benefiting from the shift of production lines out of China, which he recently demonstrated against Vietnam and India. It is no secret that he wants US companies to move these activities to US shores.

More generally, our calculation shows that the trade war is weighing on global trade and global economic growth and this effect seems to be dominating (Figure 4). Moreover, we might have to revise our forecasts if the Trump administration decides to target Europe or Japan with additional protectionist measures or if the UK leaves the European Union without a deal, as these events are not yet incorporated in our baseline. On balance, we conclude that, at best, India may only benefit from the trade war in a relative sense, not in an absolute sense.

Downward risk II: lower potential growth

Another downward risk to our forecasts is that we might even be too optimistic about India’s structural growth trajectory. As mentioned, we are already far less optimistic than the IMF about India’s potential growth (Figure 3): we believe that the Modi government has implemented insufficient reforms in the second half of its first term and it has made no new announcements in the Budget for fiscal 2019/20. Additional reforms, however, are necessary to push Indian growth toward levels of 7%.[4]


Over the past quarters we have revised our forecasts downwards several times based on our nowcasting methodology. Currently, however, there is insufficient high-frequency data to make a proper judgment about a possible rebound for fiscal q2, but we will continue to monitor the situation (Table 2) and will adjust accordingly. That said, the sparse data available for July does not point to a strong rebound, with vehicle sales in that month plunging even further: -23.5% y-o-y. The purchasing managers’ indices (both manufacturing and services) are looking bleak as well., We cannot therefore rule out the possibility of a downward revision of our forecast for fiscal q2 (when sufficient high-frequency data is available).

Table 2: Leading indicators in July are still flashing red
Table 2: Leading indicators in July are still flashing redSource: Macrobond, Rabobank

Substantial stimulus package needed

Besides the policy measures already in place, the Indian government has also announced several plans to stem the current economic slump. In order to reinvigorate credit growth in India, on 30 August Finance Minister Nirmala Sitharaman announced that ten state-owned banks will be merged into four entities. The INR 700bn capital infusion for banks announced in the Budget will also be accelerated. Other measures are the removal of a surcharge on portfolio investments, announced in the July Budget and government plans to renew its vehicle fleet.

Figure 5: No room for a large-scale fiscal stimulus
Figure 5: No room for a large-scale fiscal stimulusSource: Macrobond, FRBM, Rabobank, Budget

Although these plans are a step in the right direction, we feel they are insufficient to revive the economy in the short term, especially since these measures are not accompanied by a policy agenda containing structural reforms (e.g. in the F&A sector, land reforms, labor market reforms). We feel that a much more substantial stimulus package would be required to lift the spirits in the Indian economy. However, due to its unfavorable fiscal position, the government only has limited options to launch such a package (Figure 5). Admittedly, on 26 August the RBI announced a dividend transfer of INR 1760bn, which was more than the government had budgeted for fiscal 2019/20. However, given the lower than anticipated growth of the Indian economy, the excess funds of 860bn will most likely be needed to prevent substantial fiscal slippage. In short, we do not expect that the government can allocate these funds for fresh stimulus.

Accommodative monetary policy

Given the government’s limited headroom to launch a large-scale fiscal stimulus program, the only actor able to provide stimulus in a relatively painless manner is the Indian central bank. The RBI has already provided monetary loosening by slashing its policy rates by a spectacular 110bps this year. We believe, however, that there is even more headroom for accommodative policy. Firstly, we expect inflation to move well below the RBI’s mid-point target range (Figure 6). Although we expect oil prices to rise to 74 later this year, the normal monsoon and increase in the output gap will prevent a substantial upward pressure on prices.

Figure 6: Inflation is expected to stay below RBI’s mid-point target range
Figure 6: Inflation is expected to stay below RBI’s mid-point target rangeSource: RBI, Macrobond, Rabobank
Figure 7: US Fed cycle provides room for accommodative EM monetary easing
Figure 7: US Fed cycle provides room for accommodative EM monetary easingSource: US Federal Reserve, RBI, Macrobond, Rabobank

Secondly, our (slightly revised) Fed view foresees two more cuts this year and a full-blown cutting cycle starting in 2020 (Figure 7). This will provide breathing space for emerging markets to ease monetary policy without triggering substantial capital outflows. However, we expect that the RBI does not want to push the policy rate differential against the US Fed Fund Rate below 3% (Figure 3). Ultimately, we think the RBI will cut its policy rates by 40bps after the October MPC meeting and another 25bps in December, before initiating a pause. As we anticipate a recession in the US later in 2020 which will trigger a full-blown cutting cycle by the Fed, we expect a pre-emptive cut of 25bps by the RBI in fiscal q2 of 2020.

INR trajectory expected to remain elevated

Figure 8: INR moving at elevated levels
Figure 8: INR moving at elevated levelsSource: US Federal Reserve, RBI, Macrobond, Rabobank

Despite our revised forecasts, the trajectory of our USD/INR forecasts is not substantially altered (Figure 8 and Table 3). In our election update of May 2019, we stressed that we expected the INR to slide to 72 later this year. Back then, we also said that oil prices were expected to move to 74.5 USD/bbl, caused by geopolitical tensions between Iran and the US/Saudi-Arabia, as well as the oil sanctions against Venezuela.

Indeed, USD/INR breached the 72 level early September after touching 68 in July, but recovered somewhat on the back of optimism that the US would be willing to work on an interim deal with China in October. We do not rule out the possibilities of an interim deal, where China pledges to buy more (agricultural) goods in exchange for exemption from higher tariffs or a short postponement of Huawei sanctions. However, due to fundamental differences on matters such as Intellectual Property Rights violation, subsidies for China state-owned enterprises, forced technology transfer by foreign firms operating in China and limited market access in China, it seems highly likely that trade talks will break down… again and Trump will up the ante…again. We have seen this ‘one step forward, two steps back’ scenario unfolding already twice this year. Moreover, a White House official already stated that the US is “absolutely not” willing to accept an interim deal, so markets should not get their hopes up.

Table 3: INR forecasts
Table 3: INR forecastsSource: Rabobank

In the medium term, the negative impact of lower growth for the Indian economy on the INR should be partly mitigated by lower expected growth of the US economy caused by the trade war. This keeps the US-India economic growth gap in check, which is an important determinant of the USD/INR rate. Moreover, we have revised our inflation forecasts downward, which is an INR positive.

Final remarks

Given the substantial uncertainty about the shape of the Indian economy, we will continue to monitor the situation and, if needed, further adjust our forecasts. As the economy is currently going through a major slump, we do not think that the anticipated weakness of the global economy (which we expect to slow down from 3.7% in 2018 to 3.1% in 2019 and 2020), will result in a double dip in India. We expect the US economy to slide into recession in the second half of 2020, and by that time we expect the Indian economy will start closing the output gap. Another positive aspect of the weak GDP print is that it will hopefully put an end to the harmful discussion about the reliability of India’s GDP data and possible government interference; allegations to which we have never attached much faith.

Annex I: Rabobank’s forecast framework for India

Annex II: Timeline of the China-US trade war


[1] See Annex I for an overview of Rabobank’s forecast framework for India.

[2] President Trump announced he would raise tariffs to 30% on the remaining USD 270bn of Chinese export goods to the US (broken down in two tranches of USD 110bn in September and USD 160bn in December. China responded by raising tariffs as well and allowing its currency (CNY) to breach the psychological level of 7 per USD. See Annex II for a complete overview of the timeline of the trade war:.

[3] The WWTG index measures which emerging markets are most likely to benefit from a relocation of production activities from China based on four criteria: 1) export basket similarity compared to China, 2) real manufacturing wages, 3) the attractiveness of the long-term investment climate measured by the World Bank Ease of Doing Business index and 4) institutional quality measured by the World Bank Governance Indicators.

[4] Later this year, we will initiate in-depth research on India’s growth trajectory from a more structural angle.

Hugo Erken
RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
+31 6 2223 1650

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