India: three growth drivers (and a drag)

India’s growth outcomes for the last three quarters have surprised to the upside and high frequency activity indicators for the first quarter of calendar 2024 reflect sustained momentum.

As a result, ANZ Research has revised its growth estimate in India for the year to March 2024 from 6.9 per cent to 8 per cent.

The current growth cycle is likely now peaking, and softer growth rates lie ahead. For fiscal 2025, ANZ Research expects India’s GDP growth to slow down to 6.8 per cent, below the Reserve Bank of India’s (RBI) 7 per cent estimate.

Expect further private capex revival, but moderate consumption demand will likely cap the upside. A sharp pullback in fiscal expenditure will weaken growth while past policy rate hikes are still transmitting to the economy. That said, India’s relative growth differential is likely to remain favourable.

Bolstered

India’s start to calendar 2024 has been defined by three growth drivers and a drag.

Firstly, a receding commodity price shock has bolstered industrial activity, and high-frequency indicators, including the manufacturing purchasing managers index, portend a further recovery in the sector. The share of manufacturing in gross value added has not yet normalised.

Secondly, exports have been an important tailwind to growth. India’s net export drag on growth is alleviating thanks to a swifter rebound in exports. Rising goods-export growth is also likely feeding into industrial recovery. Services exports, which have acquired a structurally stronger footing due to the ongoing expansion in global capability centres, have been an important contributor as well.

Thirdly, India’s annual investment-to-GDP ratio has risen from 31.6 per cent before the pandemic to 33.7 per cent. Public capex has been strong, and the central government has raised its allocations further to 3.4 per cent of GDP for fiscal 2025.

ANZ Research sees stronger signs of a private capex revival, which had been the weak spot in India’s growth story over the last decade. Strong future growth prospects, macro stability, cleaner bank balance sheets, elevated public capex, receding economic uncertainty and an upswing in the overall construction cycle have been the drivers of India’s capex story.

It is also worth noting a robust growth cycle has not upset the core inflation or widened the current account deficit. This points to a higher potential growth than before, which is likely in the vicinity of 7 per cent.

There is a drag to be found, however, in the persistent weakness in private consumption demand. A subdued revival in rural indicators, such as wage growth, terms of trade (the rural-to-urban consumer price index, or CPI) and two-wheeler sales - alongside softening growth in urban indicators such as air travel and durable goods sales - point to narrowed consumption inequality, but aggregate consumer spending has failed to gain momentum.

High inflation has been a headwind to consumption, while the post-pandemic demand surge has receded. Private consumption accounts for over 55 per cent of India’s GDP, and it will be difficult for the economy to sustain high growth unless consumption growth picks up. ANZ Research expects India’s growth profile will remain dominated by investments for longer.

Inflation divide

India’s inflation is largely a food price problem thanks to erratic weather in the last cropping season. Food inflation has been easing as expected but was still elevated at 7.7 per cent in February 2024. Price pressures persist in both perishable (vegetables) and non-perishable categories (pulses and spices).

Food inflation is an important driver of ‘adaptive’ household inflation expectations, which are still elevated. However, high food inflation has not yet spilled via second-round effects into core inflation.

Core inflation (headline CPI ex-food and fuel) eased to its historical low of 3.4 per cent in February 2024. A solid supply-side recovery amid weak consumption demand, steady commodity prices and well-anchored business inflation expectations have all contributed to lower core inflation despite strong GDP growth.

Core inflation can fall further in the coming months, but it will bottom out in the third quarter. ANZ Research expects inflation to reach 5.4 per cent in 2024 and 4.3 per cent in for 2025.

Balance of payments health

A swifter rebound in exports has moderated the monthly goods trade deficit, while a rising services trade surplus reflects a structurally superior footing for India’s current account balance. Remittances continue to grow at a steady pace.

ANZ Research expects portfolio flows to remain healthy overall, buoyed by India’s robust growth and macro stability, alongside factors such as bond index inclusion. This will also help offset the weakness in the foreign direct investment account, which is unlikely to last, in our opinion.

ANZ Research has revised its fiscal 2024 current account deficit forecast for India down to 0.8 per cent of gross domestic product (GDP). In fiscal 2025, that’s expected to widen but remain manageable at 1.5 per cent of GDP. Expect a decent balance of payment surplus in both years.

Policy prudence

Thanks to buoyant tax collections, ANZ Research expects the central government to meet its fiscal 2024 revised fiscal deficit target of 5.8 per cent of GDP, 10 basis points lower than the budgeted estimate. For fiscal 2025, a sharp reduction in revenue expenditure is slated to help lower the fiscal deficit ratio to 5.1 per cent of GDP.

If commodity price shocks remain at bay, the government will likely be able to meet its medium-term fiscal deficit target of 4.5 per cent of GDP by fiscal 2026. The combined deficit of states will remain under 3 per cent of GDP.

ANZ Research thinks the RBI will wait for both current inflation and inflation forecasts to fall into a palatable range of 4 per cent to 4.5 per cent before dialling down its hawkish stance, likely in June 2024. The monetary policy committee is expected to cut the policy rate by a total of 100 basis points, starting August 2024. The rate-cutting cycle will mostly be to recalibrate the ex-ante real policy rate, preventing it from rising too much at the cost of future growth.

Until then, ANZ Research expects the RBI to express its growing comfort with inflation via the liquidity route, preferring narrower deficits to keep the call rate aligned with the repo rate.

Dhiraj Nim is an Economist & Sanjay Mathur is Chief Economist Southeast Asia and India at ANZ Research

This article is an excerpt from the ANZ Research report “ANZ Research Quarterly: decorrelated easing cycle at hand”, published March 26, 2024