Emerging

Gloomy prospects

st  
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EcoEmerging// 1 quarter 2020  
economic-research.bnpparibas.com  
India  
Gloomy prospects  
India’s real GDP growth remains far below its long-term potential, and economic indicators do not suggest a significant turnaround  
in the short term. The government has little manoeuvring room to stimulate the economy. In the first eight months of the fiscal year,  
the budget deficit already amounted to 115% of the full-year target, and the central bank must deal with rising inflationary  
pressures, which are hampering its monetary easing policy (which is not very effective anyway). The prospects of materially lower  
economic growth has led the rating agency Moody’s to downgrade its outlook to negative. Yet it is the financing of the economy as  
a whole that is at stake.  
Growth falls far short of potential  
1-Forecasts  
In the second quarter of the current fiscal year (July-September  
019), India’s GDP growth slowed sharply to only 4.5% year-on-  
2
018 2019e 2020e 2021e  
2
(
1)  
Real GDP growth (%)  
6.8  
3.4  
4.8  
5.5  
6.0  
year (y/y). This brings growth in the first half of 2019/20 (fiscal year  
ending 31 March 2020) to 4.8%, down from 5.4% in the year-earlier  
period. This is the sharpest slowdown since 2013, even though  
conditions are much more favourable now than in the past. In the  
first six months of the fiscal year, inflationary pressures were under  
tight control (+3.3% vs +11.3% in 2013/14) and the monetary  
authorities cut the key rate by 135 basis points (bp), even though  
the move was only very partially carried over to interest rates on  
new loans. Oil prices are also much lower than in 2013 (-43%) and  
international investors have shown confidence in the new Modi  
government. Yet despite government and central bank measures,  
growth has been hard hit by the sharp slowdown in household  
consumption (the main growth engine) and investment, albeit to a  
lesser extent. Although net exports continue to make a positive  
contribution to growth (due to the decline in imports), exports  
contracted in the current fiscal Q2. Lastly, Q3 economic indicators  
do not suggest a strong rebound in activity in the short term. In  
October, power generation and coal production contracted for the  
third consecutive month. In manufacturing, production capacity  
utilisation rates have dropped to the lowest level since 2013, and  
production of capital goods and consumer goods have declined by  
(
1)  
Inflation (CPI, year average, %)  
4.3  
4.5  
4.5  
(
1)  
General Gov. Balance / GDP (%)  
-6.3  
-7.2  
-6.9  
-6.7  
(
1)  
General Gov. Debt / GDP (%)  
69.8  
-2.1  
70.7  
-2.1  
70.8  
-2.2  
70.6  
-2.4  
(
1)  
Current account balance / GDP (%)  
(
1)  
External debt / GDP (%)  
20.0  
393  
19.9  
457  
20.0  
493  
20.0  
530  
Forex reserves (USD bn)  
Forex reserves, in months of imports  
Exchange rate USDINR (year end)  
9.1  
9.4  
9.6  
9.8  
71.0  
71.3  
73.5  
73.9  
(
1): Fiscal year from April 1st of year n to March 31st of year n+1  
e: BNP Paribas Group Economic Research estimates and forecasts  
2
- Industrial output  
(
y/y, 3-month moving average, %)  
Total industrial output  
Durable consumer goods  
▪▪ Capital goods  
20  
1
5
0
5
0
5
1
21.9% and 18% y/y, respectively.  
Scant means to boost growth in the short term  
-
The monetary and fiscal manoeuvring room to stimulate growth is  
extremely limited.  
-10  
-
15  
20  
-
The big problem for the monetary authorities is that the monetary  
policy transmission channel is not working well. Moreover, the rise  
in inflationary pressures since September (+5.5% y/y in November  
-25  
2015  
2016  
2017  
2018  
2019  
2
019, compared to a target of 4% give or take 2 percentage points)  
Source: CEIC  
is now limiting its policy to stimulate growth. Citing price increases,  
the monetary policy committee opted to keep key rates unchanged  
at its most recent meeting in December. The authorities must also  
support the financing of non-banking financial companies, the main  
source of the big surge in lending since 2017.  
year target. Even though the government frequently reports a  
surplus in the fourth-quarter of the fiscal year, it will not suffice to  
reach the government’s deficit target of 3.3% of GDP.  
Faced with these constraints, the government adopted other strong  
measures, including a significant cut in the corporate tax rate, the  
privatisation of four major state-owned companies and labour  
market reform. Although these measures are major advances, they  
will not stimulate growth in the short term. Corporate investment will  
Using fiscal policy to stimulate growth is also heavily restricted by  
the risk of deficit slippage in the current year and fears that its  
sovereign rating would be downgraded by the international rating  
agencies. In the first eight months of the fiscal year (April to  
November), the fiscal deficit already amounted to 115% of the full-  
st  
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EcoEmerging// 1 quarter 2020  
economic-research.bnpparibas.com  
continue to hinge on a recovery in household consumption, which in  
turn depends on a significant improvement in lending conditions,  
notably for non-banking financial companies.  
3
- Rising inflationary pressures  
y/y % change  
7
Headline inflation ▪▪ Core inflation (excluding food and energy prices)  
Faced with this environment, growth forecasts have been revised  
sharply downwards for the next two fiscal years. Growth could fall  
below 6% after averaging 7.5% over the past five years. A lasting  
slowdown in growth would not only hamper job creations, which  
already fail to cover new entrants to the job market, it would also  
strain the consolidation of public finances, Indian companies  
7
6
5
4
3
2
1
0
6
5
4
3
2
1
0
(
underway since 2014) and the banking sector. As things currently  
stand, fears of materially lower economic growth led the rating  
agency Moody’s to downgrade India’s sovereign rating to a negative  
outlook.  
What are the risks in terms of debt sustainability?  
2
015  
2016  
2017  
2018  
2019  
Public debt could exceed 70% of GDP as of fiscal year 2019/20. For  
the moment, however, refinancing risks still seem to be limited.  
Source : RBI  
At year-end 2018/19, public debt already amounted to 69.8% of  
GDP (i.e. 285% of the annual revenues of the central and state  
governments), a 2.8-point increase compared to 2013/14, even  
though the fiscal deficit of all public administrations declined (to  
better than for the state-owned banks. Although the share of  
doubtful loans was rising in Q3 2019, it was still limited to 6.3% of  
loans outstanding, and the solvency ratio was 19.5% (well above  
the regulatory threshold of 15%). The central bank has also adopted  
a regulation that requires NBFC to comply with a liquidity ratio of  
6.3% of GDP in 2018/19 from 7.5% in 2013/14). This increase  
reflects the increase in “off budget” expenditure, notably by the  
States.  
1
00% as of December 2020. The main risk, other than a severe and  
As part of its public finance consolidation programme, the  
government is aiming to reduce the public debt ratio to only 60% of  
GDP by 2024/25. Yet this target does not seem feasible in the light  
of current growth prospects.  
lasting slowdown in economic growth, is a downturn in the housing  
sector. The exposure of NBFC as a whole is not very high (6% of  
loans outstanding), but this is not the case for Housing Financing  
Companies (HFC) specialising in mortgage loans for the real estate  
sector. Commercial banks, which are still very fragile, are also  
highly exposed to the real-estate sector (22.5% of lending) which is  
in the midst of a downturn. In 2018/19, new housing starts  
contracted for the third consecutive year. Sales reported by listed  
real-estate companies contracted by 27.8% in Q3 2019, and house  
prices continued to slow (+2.8% y/y in Q3 2019).  
If growth were to hold below 6% on average through 2022/23, the  
public debt ratio would exceed 70% of GDP over the next three  
years, assuming the government manages to hold the primary  
deficit below the threshold of 2% of GDP (1.4% of GDP in 2018/19).  
Yet even though India’s public debt is among the highest in the  
emerging countries, its structure is not very risky and refinancing  
risks are limited. India’s debt has long maturities (averaging 10  
years), is held mainly by residents (more than 96%) and is  
denominated in the local currency (97%). Yet the government still  
has major financing needs that are straining growth. The IMF  
estimated its needs at 11.4% of GDP in 2019. Moreover, for fiscal  
year 2018/19, interest payments amounted to 5.3% of GDP, the  
equivalent of 21.7% of total revenue. Although refinancing risks are  
limited, any increase in government financing needs could squeeze  
out financing for the rest of the economy. Banks are the main  
buyers of public debt securities (39.1%) and financing has been  
lastingly reduced for non-financial companies.  
Banking and financial sector: downturn in the  
housing market creates new risks  
Faced with the sharp increase in the cost of financing, due notably  
to outflows from mutual funds following the bankruptcy of IL&FS in  
September 2018, loans granted by non-banking financial companies  
(
NBFC) have dropped off sharply since Q3 2019 (-36% y/y). On the  
whole, the NBFC still boast a solid financial position, which is much  
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