India: Improved macro picture despite dip on demonetization - Commerzbank

Analyst, Charlie Lay at Commerzbank, expects that the Indian government’s surprised demonetization move in early November-2016 is expected hit growth in late 2016 and possibly early 2017.

Key Quotes

“The removal of INR500 and INR1,000 bills severely affected commerce, ranging from private consumption to production. We see full year 2016 growth at 6.8% from above 7% previously. We maintain 2017 and 2018 growth at above 7% but the risks are to the downside, particularly for 2017. The economic damage is still unknown but could be significant given that the high-value notes account for 86% of cash in circulation and 10% of the money supply in a still largely cash-based economy. The risks lie to the downside. The demonetization move was driven by the need to tackle counterfeiting, nullify the black market, and curb funding of terrorism. This is an unpopular move given the inconvenience but at the same time, it demonstrates PM Modi’s willingness to make tough decisions for the benefit of the economy longer out. The positives are that private consumption should remain a key driver in H2 2017 due to 1) the good monsoon in 2016 which should support rural spending; and 2) implementation of the 7th Pay Commission award. Higher public sector capital spending, led by roads and railways, should also help growth.” 

“RBI rate cuts nearing an end

Lower inflation in the past two years allowed RBI to cut rates by 125bp in 2015 and another 50bp up to November-2016 to 6.25%. We could see another 25-50bp cut in December-2016 to offset the drop in money supply. We could see another 50bp in 2017 given that inflation is expected to remain contained around 5% in 2017. The good monsoon this year should also help to keep food prices under control. The main risk factor remains an uptick in oil prices.”  

“Improved fundamentals the best defence 

India remains one major beneficiary of low commodity and oil prices in 2016. The positives are seen in three areas, including 1) lower current account deficit, seen around 1% of GDP for 2016 and 2017; 2) stable fiscal deficit, projected at 3.5% in 2016 and 3.4% in 2017; and 3) lower inflation, helped by lower food prices. It is seen around 5% in both 2016 and 2017.”

“INR to move in line with regional counterparts

USD-INR was remarkably stable for most of 2016, holding within a 4% range between 66.00-69.00. For 2017, we expect INR to weaken further but to be in line with the rest of Asian currencies. We see USD-INR rising towards 71.50 by end-2017.”