India’s economy has recovered strongly from the Covid-19 shock, led by a rebound in (contact-intensive) services. Growth is likely to moderate in the coming quarters, given fading reopening gains, depletion of household pandemic savings, the lagged effects of monetary policy tightening, the withdrawal of Covid-related fiscal relief measures, and external headwinds from a looming Western recession.
However, India is expected to remain among the fastest growing major economies of the world, with around 6.0 per cent growth expected for FY24-25e (vs. 7.2 per cent for FY23).1 India is less vulnerable to slowing global demand than many of its EM peers, as exports currently make up less than a quarter of GDP. Urban consumption has been robust while rural demand is showing signs of recovery, amid an improving labour market and rising rural wages.
Robust growth recovery
Source: CEIC, Bloomberg, HSBC AM, May 2023
An El Nino phenomenon remains a risk to growth and inflation outlook, as about 60 per cent of the rural population is employed in the agricultural sector.1 However, structural improvements in the rural economy, including expanded roads, irrigation and water-storage capacity, digitalisation, and better credit access, etc., have reduced the monsoon dependence of agriculture. There has also been significant diversification in the rural economy with increasing contribution from non-farm sectors to rural income.
Improved balance sheets support a capex cycle
The economic recovery has driven a strong pickup in credit growth in FY23. While credit growth may have peaked off due to a tapering of pent-up demand and the transmission of higher policy rates into lending rates, improvements in bank and corporate balance sheets remain supportive of the credit cycle, while the household leverage stays low. The debt-to-equity ratio of listed Indian corporates has generally trended lower since 2018.1
Indian banks’ asset quality has improved, following a large-scale clean-up of stressed assets since 2015, and they are well-capitalised now. The gross non-performing asset (NPA) ratio of scheduled commercial banks fell to a seven-year low of 5.0 per cent in September 22 from 11 per cent in March 2018, while the average capital-to-risk-weighted -assets ratio (CRAR) rose to 16 per cent from 13.8 per cent.2 This bodes well for a pickup in the investment cycle, amid the fiscal thrust on infrastructure and with signs of a corporate capex revival in select sectors hinted by new project announcements. Meanwhile, the housing market recovery is backed by strong pent-up demand, high affordability and declining unsold inventory. Favourable demand-supply dynamics may help cushion the impact from higher mortgage rates.
Relatively low private sector debt ratios within EM
Source: IIF, CEIC, Bloomberg, January 2023
Prudent FY24 budget with capex focus
The Indian government’s balance sheet remains stretched. Its gross debt-to-GDP ratio at 81.3 per cent in Q4FY23 was high in the EM context, albeit off the FY21/22 peak (of ~90 per cent).3 The primary deficit was sizeable at 3.0 per cent of GDP in FY23 vs. the 2017-19 average of 0.35 per cent.3 However, the FY24 Union Budget managed to strike a fine balance between (capex-led) growth support and fiscal consolidation. It targets a central-government fiscal deficit of 5.9 per cent of GDP, down from 6.4 per cent in FY23.3 This reflects the government’s commitment to a medium-term fiscal consolidation glide path, further lowering the deficit to 4.5 per cent of GDP by FY26.3
The quality of spending mix will improve, with a continued infrastructure push (and the intention of increasing private capex which is key for sustainable growth) and a further reduction in the food and fertiliser subsidy bill. The budget also provides continued support for the middle class, jobs creation, climate change targets and expansion of local manufacturing supply chains in strategic segments such as electronics. The budget also aims to improve tax compliance with further efforts towards tax simplification.
Overall, fiscal policy is supportive of India’s domestic demand strength and productivity gains, while keeping fiscal sustainability and overall macro stability concerns in check. The FY24 budget resisted populist temptations in a pre-election year, though there will likely be more policy pledges to support the rural economy and bottom-of-the-pyramid segment in the run-up to 2024 general elections (and state elections in the coming few months). That said, robust tax collections so far and a large RBI dividend transfer may help keep fiscal consolidation on track.
Improving quality of government expenditure
Note * budget estimates; Source: CEIC, Bloomberg, HSBC AM, May 2023
Reduced external vulnerability
Global oil/commodity prices coming off their 2022 peaks have eased pressures on India’s current account (CA) balance and inflation. We expect the CA deficit to narrow to about 2 per cent of GDP or below in FY24/FY25, a sustainable level, after widening to 2.7 per cent in the first three quarters of FY23 from 1.2 per cent in FY22.4 India’s goods exports would come under pressure from weaker global demand, but there could be an offset from potentially lower (or limited rises in) commodity prices.
There has been a structural shift in India’s balance of payments (BOP) dynamics. Strong services exports and rising remittance inflows have helped offset the deterioration in the goods trade balance. Global digitalisation during the pandemic, the growing trend of remote working, and greater acceptance among multinationals (MNCs) to run operations remotely have increased demand for off-shoring and exports of services in software/IT and R&D, where India has a comparative advantage, and a wide range of other professional services (e.g. business consulting). We expect India’s services exports to hold up better as compared to goods in a global downturn, even assuming some mean-reversion (stabilisation) following a service trade boom.
This coupled with prospects for a structural uptrend in foreign direct investment (FDI) in India and strong FX reserves adequacy has reduced its external vulnerability. FDI picked up significantly during the pandemic, driven mainly by a surge in computer software services, but fell in FY23, likely in part reflecting some payback effect and global push factors (e.g. tighter financial conditions). While global uncertainty clouds the cyclical FDI outlook, structural reforms and transformation improve India’s prospects for FDI in the medium-to-long term (discussed later). The rise in FDI will reduce India’s dependence on portfolio capital flows to fund its CA deficit.
Strong services exports; narrower goods trade deficit
Source: IIF, CEIC, Bloomberg, January 2023
Moderating inflation provides policy room for RBI
Headline CPI inflation fell to 4.7 per cent yoy in April from 7.4 per cent in September 2022, with price moderation across food, fuel and core measures.5 The trend reflects the base effect, easing supply-side shocks on goods prices and transport costs, and the lagged impact from monetary tightening.
We expect inflation to remain within the RBI’s tolerance band (4 per cent medium-term target+/-2 per cent), averaging ~5 per cent in FY24. Lower input cost pass-through and weaker domestic demand should help tame core inflation, as inflation expectations have been kept anchored, despite some uncertainty over drug price hikes, housing inflation, and wages Lower farm input costs and government supply-side measures may help keep food price inflation in check.
A gradual disinflation trend combined with reduced BOP risks – helped also by our expectation of Fed policy pivot at the turn of the year – and a decent real interest rate buffer would allow the RBI to focus more on domestic growth and stability considerations. RBI stood pat at its April meeting and indicated continued data dependence. We think a policy pause is likely in the coming months, with the potential for rate cuts (unwinding of the cumulative 250bp hikes) in H2FY24 if disinflation gains further traction.
A gradual disinflation trend provides policy room
Source: CEIC, Bloomberg, HSBC AM, May 2023
Structural growth story remains intact
Overall, India is well positioned to navigate global head-winds, backed by its robust domestic demand, improved macro stability, and favourable structural growth story. We believe a turnaround in the (private) manufacturing capex cycle is key to India’s medium-term growth potential.
Rapid digitalisation and India’s big infrastructure push are helping to lift productivity. The digital infrastructure “India Stack” brings together digital payments and identification to expand financial inclusion. It has also been used as a platform to foster innovation, expand markets, and improve public expenditure efficiency and services. Policies such as ‘Make in India’ and the Production-linked incentive (PLI) schemes, which incentivise domestic production in strategic industries such as semiconductor and display, mobile devices, pharma, food processing and autos, etc. help facilitate digitalisation.
PLIs aim at enhancing India’s manufacturing competitiveness and exports, attracting FDI, and promoting (skilled) jobs, though challenges remain that require continued policy and reform efforts. India presents itself as an alternative location for MNCs looking to diversify their supply chains (e.g. the China+1 and friend-shoring opportunity), given its comparatively low production costs, huge domestic market (amid a fast growing middle class), and the government’s reform agenda improving India’s ease of doing business and deepening its integration into global value chains. There is also a growing trend of outsourcing labour demand and offshoring to India, making it “the office of the world.”
Structural reforms in areas such as real estate, banking, insolvency and bankruptcy, tax (e.g. corporate tax rate cuts and the goods & service tax, GST), direct-subsidy transfers, and sector deregulation are starting to bear fruit, though progress in the relatively more contentious reforms (e.g. labour and divestment/ privatization) is slow and may be further delayed due to a busy political calendar over the next 12 months. Further improvements in education, health, (higher-paying, skilled) job creation and other favourable socio-economic policies will help India reap its demographic dividend, particularly its large young workforce. Successful structural transformation and improving productivity dynamics could lead to a higher savings rate (driven by higher export income, improving corporate profitability and higher household income and saving), which will ultimately help finance a higher level of investments.
Rapid digitalisation; strong FDI inflows during Covid
Source: Morgan Stanley Research, CEIC, HSBC AM, May 2023
Source: CEIC, Bloomberg, HSBC Asset Management, May 2023.
Author: Renee Chen, Senior Economist and Investment Strategist, HSBC Asset
Management. To find out more please contact Andrew Mackie, Wholesale Business
Development on +44 (0) 77 967 04191 or email andrew.g.mackie@hsbc.com
Note 1: Source is CEIC, HSBC Asset Management as of May 2023.
Note 2: Source is CEIC, Bloomberg as of January 2023.
Note 3: Source is India government sites, Reserve Bank of India, CEIC, May 2023.
Note 4: HSBC Asset Management, May 2023
Note 5: Source is CEIC as of May 2023.
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