RaboResearch - Economic Research

India’s economy gets back on track

Economic Update

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  • Year-on-year GDP growth came in at 20.1%. Unfortunately, this strong GDP growth in Q2 is rather misleading, as this is, first and foremost, a result of the very low base of 2020.
  • Mobility is at the highest point since the start of the pandemic, which bodes well for private consumption and business activity going forward.
  • RBI will favor accommodating economic recovery over normalizing monetary policy, as we expect inflation to remain within the RBI’s target band in the short term.
  • On Friday, September 24, the first in-person Quad meeting between Australia, India, Japan, and the US was held, followed by an ambitious agenda for future cooperation.
  • The agenda includes fostering Covid-19 vaccination efforts, infrastructure collaboration, climate action, innovation in key emerging technologies, and fostering talent.
  • The aim is to increase the power of the four democracies to promote “free, open, and rules-based order” in the Asia-Pacific region.
Figure 1: Economic forecast
Figure 1: Economic forecastSource: Macrobond, RaboResearch

Sometimes, the way data are presented can be misleading. GDP growth numbers for Q2 (calendar year) are a case in point. Although the year-on-year GDP growth rate came in at a strong 20.1%, this was, first and foremost, a result of the low base in 2020. In fact, Q2 economic performance was very much disrupted by the second Covid-19 outbreak. As a result, economic output fell below pre-Covid levels(-9.2% compared to Q2 2019) once again after having surpassed pre-Covid levels in Q1. Unsurprisingly, this was mainly due to a drop in private consumption and private investments. On a more positive note, exports continued to grow, reaching record highs – 8.7% above pre-Covid levels (Q2 2019). This limits the country’s trade deficit at 1.9% of GDP in Q2.

Luckily, the number of new Covid-19 infections has been declining since mid-June. Going forward, this should have a positive effect on economic activity, particularly private consumption and business spending. This is underlined by Figure 2, which shows the mobility patterns of the Indian population. Mobility is now at its highest point since the start of the crisis, indicating that people are less afraid of getting infected and increasingly active. This will benefit the service sector especially (see Figure 3), as the falling number of cases also means fewer restrictions, which, in turn, allows people to spend more at restaurants, hotels, and recreational activities. All in all, we expect economic output to continue to grow for the remainder of the year, and it should surpass pre-Covid output in the fourth quarter (compared to Q4 2019).

Figure 2: Indian population on the move
Figure 2: Indian population on the moveSource: Google Analytics, RaboResearch
Figure 3: Service sector beneficiary of recovery
Figure 3: Service sector beneficiary of recoverySource: IHS Markit

RBI will continue to support the economy

Figure 4: Inflation within target band
Figure 4: Inflation within target bandSource: Macrobond, *RaboResearch forecasts are dotted lines

Inflation in August decreased to 5.3% (see Figure 4), which was slightly lower than expected, mainly due to softening food inflation. We expect this trend to continue over the coming months, partly due to a combination of high base levels entering the equation, lower food inflation as a result of reduced food-supply chain bottlenecks, and the government’s projection of a solid kharif crop.

Nonetheless, there are some upside risks to inflation, as oil and gas prices continue to surge, and wholesale price inflation already saw an increase to 11.4% in August. However, we do not expect manufacturers to pass these costs on to end-users in the short term. The recovery in private demand still looks too fragile at the moment, and we should take into account the fact that the financial buffers of households have suffered a blow during the pandemic. Against this backdrop, we expect the RBI to favor a policy that would continue to accommodate the economic recovery. Domestic developments aside, much has recently happened on the geopolitical front as well.

India and partners intensifying cooperation via the Quad

Friday, September 24 marked the first in-person leadership summit of the Quad (Australia, India, Japan, and the US), in which President Biden hosted Prime Minister Morrison, Prime Minister Modi, and Prime Minister Suga at the White House. The group underlined their common interests as the world’s largest democracies in a statement that the countries would “recommit to promoting  the free, open, rules-based order, rooted in  international law and undaunted by coercion, to bolster security and prosperity in the Indo-Pacific and beyond," which they intend to foster through this partnership. The Quad announced new initiatives regarding Covid-19 vaccination efforts, infrastructure collaboration, climate action, innovation in key emerging technologies, and fostering talent.

The Quad clearly aims to counterbalance the increasing regional power of China, though this is not mentioned explicitly. India has already experienced this first hand in their serious confrontations with China last year, which negatively impacted their relationship. At this moment, it is not yet clear how the Quad’s ambitious collaboration will impact India directly. However, it is not hard to imagine that these new initiatives could lead to a further deterioration of India-China relations. This, in turn, could potentially have negative implications for India, since the country’s imports from China (15%) mainly consist of technological products like telephones, computers, and integrated circuits. On the flipside, being part of the Quad might counter some of these risks, as the collaboration brings new technological opportunities to India. The Quad notes that they will be working together to “affirm our positive commitment to resilient, diverse, and secure supply chains of critical technologies.” The partnership with advanced economies might give India access to a wide range of new and advanced technologies, while India could add value to the partnership as potential producer within “newly secured and diversified supply chains.” In such a scenario, India might benefit from the partnership, which, in the longer term, could help mitigate risks of economic coercion and should increase FDI inflows and exports. The key question might be whether India will benefit quickly enough or will first feel the negative impacts from deteriorating relations with China on the chin!

Table 1: Economic forecasts
Table 1: Economic forecastsSource: RaboResearch
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