India in 2019
By: Glen Tuan
Tags: Trade, Economics, Poverty, India, Asia

In 2019, India steadily overtook both France and United Kingdom to become the world’s fifth-largest economy at $2.7 trillion; the country continues to be governed by Narendra Modi who won a landslide victory at the 2019 election, strengthening his power in parliament. 2019 was a tumultuous year for India as real GDP growth is expected to hover around 5% for the entire year, along with geopolitical conflicts in the region and globally. This paper takes an evaluative approach in providing a snapshot of India’s economy for the year 2019 coupled with global macro predictions for the short-term.

India had five interest rate cuts in 2019, culminating at a rate of 5.15% at the end of 2019 compared to 6.5% a year ago. Moreover, the India government has limited ability to provide a growth stimulus after a substantial corporate tax cut in September that is expected to result in 1.45 trillion rupees ($20.4 billion) lost in revenue. Slashing interest rates and corporate tax rate are attempts by the India government to reinvigorate the economy and attract foreign investments. However, the expected effects are largely muted as seen from reports of bearish quarterly growth rates with the sharpest decline in the third quarter with a growth rate at 4.5%. The effects of interest rate cuts might have yet to be seen because of time lag and significant weakness in the demand sector.

Consumer Demand

Consumer demand continues to suffer in 2019. Consumer demand is the main driver of growth for India, it accounts for about 60% of its nominal GDP. As seen in figure 1 below, the real growth of consumer demand fell to a low of 2.4% in Q1 of 2019. It reflects a fundamental weakness in purchasing ability and consumer sentiment. Moreover, the unemployment rate continues its high since 2018 at an average of 7%. Although inflation-adjusted real-wage is expected to increase by 5%, this data could be augmented by the large income inequality where 1% of the top richest owns 73% of the country’s wealth (Oxfam, 2019). Poor consumer sentiment, weak job creation and credit crunch would most likely indicate that domestic consumption will remain sluggish for the year ahead in 2020, pulling the drag on economic growth.

Trade Balance

India’s trade balance has been in negative region for a few decades and it continues to worsen in 2019 compared to previous years. The macroeconomic environment remains unsettled and export sectors in the world, including India, are experiencing considerable flux in the year 2019. Global growth is expected to slow down to 3.2% in 2019 from 3.6% in the previous year. When world export is plotted against India export, we observe a high correlation between them, as seen in figure 2. India export sector trends down as trade tensions rise between U.S. and India and the U.S. and China. With engineering goods, iron, steel and aluminium being affected the most by higher tariffs imposed by the U.S. in May 2018 while domestic supply led a sharp decline in copper exports. Moreover, iron and steel also contend with heightened competition in third-world country markets.

As U.S. and China are closing on a phase 1 deal, the sky might turn slightly brighter over India’s export sector. However, prospects remain uncertain largely due to the sporadic nature of U.S. President Donald Trump. On the bright side, India’s direct exposure to US and China is modest compared to its regional peers particularly Taiwan, South Korea and Vietnam where a 40% of exports head to U.S. and China. Furthermore, with news that Samsung relocating part of its manufacturing to India, India’s export sector might improve with more trade substitutions. Going forward, I believe the opportunity in the trade war lies in the ability to swiftly and strategically substitute foreign exports that are greatly affected by the trade war. With Vietnam as the ideal inspiration, many manufacturers such as Nintendo Co. and Nike have shifted their production to Vietnam due to the trade war between the U.S. and China. However, the India government has not seemed to be actively seizing the opportunities.

Surprisingly, a sharper decline of imports to $39.58 billion helped the country lower its persistent trade deficit in August. This re-emphasizes the overall weakness in aggregate demand in India.

Overall, the trade deficit in India is expected to narrow slightly compared to the previous year. Amongst a multitude of factors, lower imports, depreciation of the Yuan and lower interest rates have caused a difficult year for Rupee that ends with an annual loss of 9% at 69.77.

Banking sector and debt

The frailty of its banking system is often cited as one of the core reasons. Many banks are still dealing with bad debts, shrinking saving rate and low investment returns. According to the bank of India, non-performing assets of banks in India has risen from 2.63 trillion rupees (US$39.96 billion) in 2014 to 10.39 trillion rupees ($146 billion) in 2018. The effect is a prolonged credit crunch and an inefficient transfer of funds.

India’s Non-bank Financial Institution (NBFI) sector poses additional risk to the India banking sector. The NBFIs have become increasingly important credit providers, accounting for nearly 19% of total loans in fiscal 2019. These NBFIs, also known as shadow banks, are not regulated equally like traditional banks. The liquidity constraints faced by NBFIs have constrained the provision of overall credit supply. Thus, there is considerable risk of a ‘white rhino’ event if there is no intervention in the shadow banking sector.

At 64% of GDP in 2018, India’s government debt burden is significantly higher than countries at a similar income level. Consequently, the interest burden stands at 23% of government revenue. India’s high persistent budget deficit is a result of consistent fiscal deficits. India has a large low-income population that will continue to limit its tax revenue base causing the fiscal deficit to worsen especially as India enters a period of low-growth and economic uncertainty. If nominal GDP growth does not return to high levels, I expect the government to face very significant constraints in narrowing the budget deficit and preventing a rise in the debt burden.

Growing uncertainty in the Middle East region and oil prices

There has been a growing tension between the U.S. and Iran especially after President Donald Trump killed top Iranian commander Qasem Solemiani in a drone strike. This poses great uncertainty in the Middle East region. Radical turns of events in the Middle East can have tremendous consequences on oil prices and the flow of trade. India buys more than two-thirds of its oil and mostly from the Middle East, making it one the most vulnerable in the region to a surge in oil prices. Investors would remain cautious and closely observe the turn of events in the Middle East.

Conclusion and long-term prospects

In the long run, India has many fundamental issues such as deteriorating infrastructure, corruption, lack of an educated workforce, brain drain, weak rule of law and poor governance that would continue to set India back. On the other hand, India’s large domestic market will continue to fuel growth as income increases especially as GDP per capita is still relatively low, albeit at a slower rate than in the past.

Prime Minister Narendra Modi’s aims for India to become a US$ 5 trillion economy by 2024 would require average real growth of 9% per annum. Assuming inflation is maintained at 4% which is the target inflation by the Monetary Policy Framework, the nominal growth rate hence has to be 13%. With the average GDP growth rate at about 6% in the last decade, India still has a long way before it can reach its goal of a US$5 trillion economy in 2024.

Fx opportunity: Short USD-Rupee currency pair

As there is no foreseeable end to the U.S.-China trade war yet, a continued devaluation of the Chinese Renminbi will put pressure on the Rupee. Moreover, there is a strong likelihood that the Reserve Bank of India would continue to cut rates in the next 6 months to tackle the lackluster performance of the economy. This will cause further pressure on the currency. Other factors such as the weakness in the equity market, low productivity growth, potential high inflation, higher government debt, lack of comparative advantage in its export sector and an inefficient banking sector will continue to take a toll on economic growth and hence the Rupee. I would recommend shorting the Rupee-USD currency pair as there is a foreseeable downward trend of the Rupee.