Room for Improvement in India But Outlook Solid

Room for Improvement in India But Outlook Solid

The RBI surprised the markets with a 50 bp cut in policy rates, yet the rupee firmed.  India stands to outperform within EM in the current environment.  The growth outlook is solid, inflation is falling, and the external accounts are in good shape.  Structural reforms have stalled, but markets have adjusted their expectations somewhat


Prime Minister Modi and his BJP won a landslide victory in the 2014 general elections.  The BJP won an outright majority of 282 out of 543 seats contested in the lower house, allowing it to rule without needing a coalition partner.  The BJP does not have a majority in the upper house, and recent setbacks in state elections suggest this may not be forthcoming.  The next general elections are due in 2019.

Modi started his term strong, enacting several structural reforms quickly.  Diesel fuel subsidies were eliminated, with the task made easier by the drop in fuel prices.  However, recent efforts have been stymied by opposition parties in the upper house.  Perhaps market expectations were too high.  Or perhaps markets (and Modi) underestimated the amount of ingrained resistance to reforms.  Either way, investors have already largely adjusted their expectations of what can actually be done in terms of structural reforms.

It’s worth noting that in the World Bank’s Ease of Doing Business Index, India ranks 142 out of 189, while Brazil ranks 120.  India slid from 140 in 2014.  The worst categories for India are construction permits (ranked 184), enforcing contracts (186), and starting a business (158).  Clearly, Modi has a lot of room for improvement.  From this perspective, one could argue that Brazil has done more to open up the economy than India, but while following more harmful macro policies.


The Reserve Bank of India cut policy rates by a larger than expected 50 bp.  The last move was a 25 bp cut in June.  Price pressures remain low, with CPI rising 3.7% y/y in August, in the bottom half of the 2-6% target range.  WPI contracted -5% y/y, pointing to no pipeline pressures ahead.  Governor Rajan has made it clear that it fiscal discipline is an important element in the reaction function of the RBI, so we expect the easing cycle to be gradual but ongoing into 2016.

GDP growth remains fairly robust at 7.0% y/y in Q2.  IMF forecasts for 2015 and 2016 growth stand at 7.5% for both years.  The composite PMI reading has moved back above 50 after one sub-50 month for this cycle in June, while the manufacturing PMI moves further above 50.  Not surprisingly, IP growth has started to pick up as a result.

Exports account for only 15% of GDP, making India fairly resistant to the global growth slowdown.  Though exports have been contracting y/y this entire year, lower energy prices have helped lower imports as well, limiting the damage to the trade balance.  India’s top trading partners are China, the US and the United Arab Emirates.  Indeed, the current account deficit should fall to around -1.3% of GDP this year before widening to -1.6% next year, well below the high near -5% of GDP back in 2012.

The fiscal numbers are India’s weak spot, but even here, improvement has been seen.  The FY2015/16 budget, Modi’s first, was not truly significant, but did contain measures to simplify the tax code.  The consolidated public sector deficit is seen by the IMF at around -7.2% of GDP this year and -7.1% next year.  Strong growth will help these numbers, but structural reforms are clearly needed.

India’s external debt metrics are solid, and compare well to other major EM countries.  Foreign reserves have recovered from the 2013 drop, and set a new record high of $355 bln in June before falling back slightly.  Our sovereign rating model views India as a BBB-/Baa3/BBB- credit.  This lines up exactly with the three major ratings agencies, and so we see no ratings risks in either direction.


The rupee is one of the best performers in EM, -4% YTD against the dollar.  This is second only to CNY at -2.5% YTD.  The worst EM performers are BRL (-35% YTD), COP (-24%), TRY (-23%), and MYR (-22%).  We expect INR to weaken with the rest of EM, but its outperformance to continue.  USD/INR is likely to test the all-time high near 68.85 from August 2013.

Indian equities are also outperforming within EM.  MSCI India is -3.7% YTD, and compares to -19% YTD for MSCI EM.  Bloomberg data show that India is one of the few EM equity markets to still see positive foreign inflows.  Through September 28, foreign equity investment stands at $3.7 bln YTD and $6.1 bln over the last twelve months.

Indian bonds have held up well.  The yield on 10-year local currency government bonds has fallen 25 bp YTD.  This is amongst the best performances in EM.  Compare this to the worst performing group that includes Brazil (+401 bp), Turkey (+291 bp), Peru (+225 bp), and Indonesia (+197 bp).  With inflation likely to remain low and the RBI in the midst of an easing cycle, we think Indian bonds are likely to continue outperforming.