Asia's Outperformer But Challenges Remain
The Indian government led by the Bharatiya Janata Party has initiated various reforms in its first year in office, and it will continue to enact incremental rather than big bang reforms over the coming years. That said, the lack of majority in the Rajya Sabha, India's 245-seat upper house, will remain a hurdle to the implementation of large-scale reforms. State elections, which will continue to take place over the coming years, will determine whether the BJP will attain an upper house majority.
We remain broadly constructive on the Indian economy, and it will become the fastest growing major economy in Asia owing to the government's pro-business initiatives and accommodative monetary policy by the central bank. We expect the country's manufacturing and services sectors to continue to perform strongly. However, weakening agricultural growth and slowing reform momentum, notably in the infrastructure sector, will weigh on overall economic growth, and we maintain our FY2015/16 (April-March) real GDP growth forecast to 7.3%.
The Reserve Bank of India (RBI) kept its repurchase (repo) rate unchanged at 6.75% at its December monetary policy meeting, and we expect the central bank to keep its benchmark policy rate steady for the remainder of FY2015/16 (April-March) as its shifts its focus towards improving the transmission of past rate cuts. The RBI left the door open for further easing, and given that medium term inflation is likely to remain subdued in FY2016/17 (coming in below the RBI's target of 5.0%), we forecast another 50bps worth of interest rate cuts in FY2016/17 to 6.25%.
We expect the Indian government to eventually implement the Goods and Services Tax (GST) system over the coming years, but the proposed implementation date of April 2016 is an optimistic one. Even if the GST Constitution Amendment Bill is passed by the upper house, ratification by at least half of the 29 legislative state assemblies is likely to be a time consuming process. Meanwhile, the proposal by the Seventh Pay Commission to hike the compensation of Indian government employees and pensioners will negatively impact the government's fiscal consolidation plans.
The Indian rupee will depreciate gradually against the US dollar over the coming years, and we forecast the unit to average INR68.25/USD in 2016 and INR69.50/USD in 2017. The RBI will continue to allow the currency to weaken in order to keep the currency competitive against its regional peers. However, major rupee weakness is unlikely as continued economic growth and positive real interest rates will lend support to the currency.
Major Forecast Changes
We maintained our major forecasts as highlighted in our previous Q12016 Country Risk Report and we highlight the key risks to our outlook below.
Upside Risks To Inflation: While we maintain our expectations for the RBI to cut rates in a bid to reignite credit growth and investment, we note that the potential of elevated levels of inflation could force the central bank to hike rates as it did in late 2013, which will not only pose upside risks to our policy rate forecasts, but also downside risks to real GDP growth. Moreover, should the Bharatiya Janata Party (BJP)-led government fail to gather the support it needs to implement fiscal cutbacks in order to maintain the deficit close to the level in FY2014/15, the elevated levels of fiscal spending will certainly present another source of upside pressure to prices.
Downside Risks To Growth: The ongoing reform drive in India will be a key driver of the country's economic recovery. High levels of bureaucracy, combined with vested interests and significant levels of legislative autonomy for state governments, mean that Prime Minister Narendra Modi could struggle to implement key reforms. A lack of progress in these key reforms could weigh on India's growth trajectory.
|e/f= BMI estimate/ forecast. Source: National Sources, BMI|
|Real GDP growth, % y-o-y||7.3||7.3||7.2||6.8|
|Nominal GDP, USDbn||2,054.8||2,123.8||2,240.2||2,448.2|
|Consumer price inflation, % y-o-y, eop||5.3||5.8||4.8||4.8|
|Exchange rate INR/USD, eop||63.04||66.15||69.00||70.00|
|Budget balance, % of GDP||-6.7||-6.6||-6.2||-5.8|
|Current account balance, % of GDP||-1.3||-1.4||-1.4||-1.3|
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