Global growth, inflation and trade data continue to remain weak. Major economies are witnessing weak growth, particularly in Europe and China. US data which has so far been decent, is showing moderation. US-China trade dispute continues to remain key source of uncertainty, negatively impacting capex, trade and markets. In response to low growth, major central banks have become increasingly dovish. China is responding to growth slowdown with moderate monetary and fiscal stimulus. Global equity and bond markets responding to expected and realized policy support and bond yields have cooled across the world as central banks turned increasingly dovish.
India growth picture remain weak, with 1QFY20 GDP at lowest since Mar 2013. Nominal GDP also plunged to 8.0% against budgeted 11% y-y which shall impact fiscal maths. Government is responding to low growth with series of announcements to bolster growth including significant corporate tax cut. We believe that most of the measures are long term in nature and unlikely to usher in quick growth revival. Recent negative growth in GST collections in September point to the grim growth picture.
Most high frequency indicators continuing to suggest continued weakness in growth led by sharp weakness in auto sales. New financing in the economy, EXIM data, tourist arrival, freight data, (PMI) Purchasing Managers Index and fuel consumption continues to remain soft. While (IIP) Index of Industrial Production rebounded in July, August data of core sector index was in negative zone.
Despite recent steps announced by government, monetary easing and decent income from RBI, there are headwinds to a quick growth revival. We note that despite aggressive rate cuts, weighted average lending rate has actually risen for outstanding loans. Global environment remains weak and weak equity market has also soured sentiments. Moreover, widespread stress in the credit market will be a key drag, especially amidst weak nominal growth. We thus believe that FY20 growth is likely to stay low in ~5.5% to 5.75% range, partially boosted by the favourable base effect.
CAD for 1Q FY20 came at -2% of GDP, up from -0.7% in 4Q which is a seasonally low quarter for CAD. Trade deficit witnesses a jump due to seasonality while receipts in invisibles was largely steady. Capital account witnessed a strong surplus at 4.0% of GDP, resulting an overall BoP surplus of US$14bn. Capital account surplus was driven by healthy inflows in FDI, FIIs and ECB borrowings.
While 2Q is unlikely to show strong surplus, overall BoP account remains comfortable. If crude remains at current levels and global risk environment doesn’t deteriorate, we should be looking at FY20 BoP surplus in the range of ~US$ 30 bn. In our base case, trade balance should remain comfortable and FDI flows should stay healthy, especially given the talks of strategic divestments. The risk is of significant growth scare in economy triggering capital outflows. Note that 1H CY19 BoP surplus has been 28.2 bn.
August inflation came at 3.21%, slightly lower than market expectations. On a m-m basis inflation rose by a moderate 0.49%. Rolling 12-month inflation is a benign 2.87%. While so far the inflation number has been benign, we are witnessing an upside pressure in food inflation led by vegetables, which is likely to result in next few readings going up. RBI increased Q2 inflation forecast by 30bp to 3.4% while keeping forecast unchanged for H2 and Q1FY21, at 3.5-3.7% range and 3.6%, respectively, thereby forecasting for inflation below target of 4% in the forecast horizon, giving RBI policy space to boost growth. Household inflation expectation have risen in the current survey reflecting near term price increase. We have upward bias on inflation compared to RBI’s forecast, particularly on the near term, but we concur with RBI that inflation should not be a concern given the weakness in growth.
RBI Monetary Policy
The RBI (MPC) Monetary Policy Committee further reduced policy repo rate by 25bp to 5.15%, broadly in line with market expectations, taking cumulative rate cut in the current cycle to 135bp. The tone of the policy statement was dovish with MPC noting policy space to address growth concerns and deciding to continue with an accommodative stance as long as it is necessary to revive growth, while ensuring that inflation remain within target. MPC also noted that negative output gap has opened further, and continued slowdown warrants intensified efforts to restore the growth momentum. On the recent fiscal measures particularly corporate tax cut, RBI has taken comfort from government’s commitment to stick to fiscal deficit targets.
While the policy statement and our growth-inflation projection indicate space for more easing in the current cycle, we note that increasingly fiscal health is becoming a cause for concern, and while RBI chose to ignore it this time, fiscal pressure will become more glaring in the next policy meeting, which shall somewhat limit the incremental monetary space available for growth. Our terminal repo rate view in the current cycle is 4.75-5.0%.
Portfolio Positioning & Market View
While we see possibility of more rate cuts, we note that government is also uncomfortable with the current growth slack and responding to low growth with fiscal measures. We are already running short on tax revenue side, and the announced corporate tax cut will add to it. Fiscal health remains a cause for concern which offsets the positive impact of monetary easing. This kind of coordinated monetary and fiscal response has increased uncertainty in the duration space. However, in 2-3 years investors may consider corporate bonds given the spread.
CAD: Current account deficit; BoP: Balance of Payment; NBFC: non-banking finance companies
Source: CEIC, Bloomberg, RBI
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