India sees slow but steady improvement - BBH

Research Team at BBH, suggests that India’s outlook remains solid and structural reforms have been seen, while the economy is in the midst of a strong cyclical recovery.  

Key Quotes

“Political outlook

Two years into Modi’s term, the reform effort has been solid.  He was able to quickly push through fuel subsidy cuts, while structural reforms since then have been slow but steady.  India is starting to reap the benefits of the reforms.  

Modi has three more years before the next general elections that are due in 2019.  Several state elections will take place between now and then.  US-India relations have improved significantly, with Modi set to address a joint session of the US Congress this week. We suspect both nations view each other as potential bulwarks against China’s growing influence in the region.

Economic outlook

The economy is robust.  GDP growth is forecast to accelerate to around 7.5% in both 2016 and 2017.  GDP grew 7.9% y/y in Q1, the strongest since Q3 2014.  Price pressures are picking up, with CPI rising 5.4% y/y in April.  While inflation is still within the 2-6% target range, it is nearing the top end of that band.  WPI moved back into positive y/y territory in April, and points to rising inflation risks.

The Reserve Bank of India kept rates steady today at 6.5%, as expected.  The RBI said that its inflation forecasts were retained, but with an “upside bias.”  Until the inflation outlook is clearer, the RBI is likely to remain on hold.  The central bank next meets August 9.  

Fiscal policy has remained prudent.  Modi cut fuel subsidies soon after taking office, which has helped the fiscal accounts.  The external accounts remain in good shape.  The current account gap was about -1% of GDP in 2015, and the IMF forecasts it to widen to around -1.5% this year and -2.0% next year.  With growth picking up and energy prices rising, we see risks of wider than anticipated deficits.  

Structural reforms have helped bring in FDI.  Foreign reserves rose to a record $363.1 bln in April before falling back modestly to $360.2 bln in May.  Reserves cover nearly 8 months of import and are about 1.5 times larger than short-term external debt.

Investment outlook

The rupee outperformed in 2015 but is lagging YTD.  In 2015, INR lost only -5% vs. USD and was behind only TWD (-4%) and CNY (-4.5%).   So far this year, INR is down -1% YTD and is ahead of only the worst performers MXN (-6.5%), ARS (-6.3%), and CNY (-1.2%).  Our EM FX model shows the rupee to have NEUTRAL fundamentals, so this year’s underperformance should ebb a bit.

USD/INR has been moving lower.  A break of the 66.71 area would set up a test of the April low near 66.  After that is the October low near 64.70.

Our own sovereign ratings model shows India to be correctly rated by all three agencies at BBB-/Baa3/BBB-.  India’s score improved slightly in Q2 and is on the cusp of BBB/Baa2/BBB territory.  Several quarters ago, we felt India was facing downgrade risks to its ratings.”