The policy pause may continue in June and rate cuts may begin in October because growth will be disappointing beyond June. There may be a 75bps (basis points) cumulative rate cut in the second half of the financial year (H2FY24), which will likely lower the repo rate to 5.75 percent by March 2024, said Aurodeep Nandi, India Economist and Vice President at Nomura.
In an interview with MintGenie's Nishant Kumar, Nandi said the trends in the trade data carry early warning signs that a more potent downturn awaits growth in the second half of 2023 and into 2024 when the global growth situation is likely to further deteriorate.
Edited excerpts:
What's your view on the March retail inflation numbers? Can we say the worst is behind or do you see fresh worries such as El Nino and crude price rise?
Overall, the March CPI inflation at 5.7 percent year-on-year (YoY) was in line with our expectations and suggests further disinflation is likely in the coming months while also vindicating the RBI’s decision to pause in the April meeting.
Core inflationary pressures are also ebbing – with momentum easing for our measure of super core inflation (core CPI ex-petrol, diesel, gold and silver).
Based on daily price data in April so far, our provisional estimates suggest April CPI inflation is tracking below 5 percent, and core CPI inflation is at nearly 5 percent versus 5.7 percent, led by base effects and lower momentum.
Beyond April, we expect inflation to average about 5 percent from Q2 of 2023 onwards, from 6.2 percent in Q1, averaging 5.3 percent YoY in 2023 and 4.9 percent in FY24.
There are risks to monitor, particularly from the climactic impact (heat waves and potentially weaker monsoons) on food inflation, although the linkage between rainfall and food inflation has been patchy in the past.
On core inflation, we believe the combination of a sharp correction in input costs and weaker growth are likely to eventually feed through to consumers, while core services inflation is already exhibiting early signs of peaking.
Importantly, the standard indicators of second-round effects – inflationary expectations, housing inflation and wage inflation – are largely under control.
The IMD has predicted a normal monsoon this year while Skymet has predicted a below-normal monsoon, with a 60 percent chance of drought, due to El Niño conditions. What is your view on the impact of looming El Nino on the country's economy and inflation?
While it is too early to assess the impact of below-normal monsoons, they typically lead to weaker food production and lower agricultural output growth. The link to food inflation, however, is not immediate.
In the past, food inflation has increased despite good rainfall and vice versa, which suggests there are many other factors that determine the food inflation outlook.
Is the pause on rate hikes by the RBI sustainable?
We broadly agree with the RBI’s FY24 inflation projection of 5.2 percent YoY, although our forecast is marginally lower at 4.9 percent.
However, we believe the RBI’s GDP growth projection of 6.5 percent YoY in FY24 is too optimistic (Nomura: 5.3 percent), and we expect more than one percentage point (PP) downside.
We expect the policy pause to continue in June.
Monetary policy works with long lags, so assessing the impact of the tightening will need more than two months’ worth of data.
Beyond June, while we expect inflation to evolve broadly in line with the RBI’s forecasts, we expect growth to start disappointing.
We maintain our view that the policy pause will give way to a policy pivot towards rate cuts, starting this October.
We expect 75bp cumulative rate cuts in the second half of the financial year (H2FY24), which will likely lower the repo rate to 5.75 percent by March 2024.
US Fed minutes projected that the US may enter a recession towards the end of the year. How could a recession in the US affect the Indian economy?
If we consider the last two US recessions – 2000-01 and 2008-09 (excluding the Covid-19 recession as it was a unique supply shock), we find that an average swing in US GDP growth (peak to trough) by -4.6pp was accompanied by close to -6pp swing in India’s GDP growth.
First, an export slowdown due to weaker global demand is the obvious and immediate casualty, which also tends to be employment intensive, so a slowdown in exports impacts employment, especially among smaller enterprises.
Second, we also find that fixed investment is less sensitive to domestic factors (business sentiment, public capex, real interest rates), and more sensitive to demand uncertainty and financial conditions, both of which take a hit during global slowdowns.
This results in phases of co-movement between export and investment cycles. As such, India’s growth cycles have largely been in sync with the global growth cycle.
India's economic growth estimates have been revised downwards by many agencies. What, in your view, can cause the domestic economy to lose its momentum? What are some bright spots?
Growth data have largely held up in Q1 2023, with early indicators for March suggesting sequential improvement in consumption and services sectors from Q4 2022 levels, but the external sector continues to be challenged.
Ideally, if a compression in trade deficit is being driven by stellar export growth or lower import dependence, then it is also a win for growth.
However, the current phase of lower merchandise trade deficit in Q1 2023 is being driven by continued weakness in core imports and a slump in exports – which apart from lower global prices, is reflective of weaker domestic demand and global demand respectively.
Hence, even as the drag to GDP from net exports is likely to be arithmetically lower, exports and imports have important backward linkages to manufacturing, employment and domestic demand.
We are concerned that the coincident indicators are yet to entirely reflect the headwinds from slowing global growth, delayed impact of domestic policy tightening and inherent weakness in private capex.
We believe the trends in the trade data carry early warning signs that a more potent downturn awaits growth in H2 2023 and into 2024 when the global growth situation is likely to further deteriorate.
A potentially weak monsoon season could also impact agri-GVA growth and rural recovery.
Consequently, we maintain our out-of-consensus view of GDP growth moderating to 5.3 percent in FY24 from around 6.7 percent in FY23, in contrast to RBI’s forecast of 6.5 percent.
However, we remain positive about India’s improved medium-term growth prospects, including a young population, stronger fundamentals and prudent policymaking, alongside the trend of supply chains diversifying away from China.
Hence, we are pencilling in a recovery to 6.1 percent in FY25.
Disclaimer: The views and recommendations given in this article are those of the expert. These do not represent the views of MintGenie.
