2018: India - Growth recovery at the expense of macro stability

Consensus said:

Markets have perceived Prime Minister Narendra Modi as a reformer, with investors still optimistic about his policy agenda.

We said:

Widening twin deficits and rising inflation are fast emerging as risks to India’s macroeconomic stability that will threaten the nascent growth revival. Historical precedence shows that spending rises ahead of elections; combined with the Modi government-driven policies such as farm loan waivers and GST rate cuts as well as a probable reduction in excise duties owing to rising oil prices, this points to the high possibility of fiscal slippage in FY19. Increasing oil prices and fiscal pressures will keep inflation above the RBI’s 4% target in FY19; the RBI will not cut policy rates to assist any growth recovery and could even hike interest rates in FY19. The current account deficit is widening owing to stronger oil prices, but non-oil imports are rising sharply too. Given that consumption and government spending are likely to drive economic activity in FY19, any growth spurt will be unsustainable, leading to macroeconomic imbalances over the medium term.

Outcome:

In this overarching macroeconomic piece at the start of the year, we made calls on the twin deficits, inflation, monetary policy and macroeconomic stability, and we have been proved right on almost every count. The only outstanding issue is the excise duty cut on fuel prices, which may still well happen before the 2019 general elections. The risk of a hard landing in 2019 is only growing as the Modi government's inability to generate a rapid growth recovery is making it fall back on populist policies, with damaging consequences for fiscal consolidation and inflation.

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