India has the second highest number of Covid-19 cases in the world and its economy shrank by around 24 per cent year-on-year in Q2-20 – one of the sharpest declines in economic output amongst the G20 nations. With the initial slower opening up of the economy, the consensus has been extrapolating this weaker growth dynamic into the future and continues to downgrade India’s growth outlook.
In contrast, we have been more positive on India’s growth prospects. At the outset, what has been missed by the consensus is that the current recession is more akin to a natural disaster than one attributed to inherent imbalances in the economy, which take longer to heal. With that in mind, we have been highlighting since May that once the exogenous shock from the Covid-19-related disruption eases and economic activity starts to normalise, a recovery in growth will take hold.
The policy response has been swift. The Reserve Bank of India (RBI) lowered rates by 115 basis points (bps) since the announcement of the lockdown, expanded the central bank balance sheet by 4.6 per cent of GDP (the most amongst large emerging markets) and announced macro prudential measures to ensure financial stability. Reflecting how accommodative these measures have been, nominal market interest rates (call rates) are at or below the lower bound of the policy rate (reverse repo) and on an inflation adjusted basis, real interest rates are negative. Indeed, real call rates are at an eight year low on both headline and core inflation.
Limited fiscal space has meant that monetary policy has done the heavy lifting. Indeed, compared to key developed market and emerging market economies, India’s discretionary fiscal stimulus is relatively low. But the government has managed to respond with targeted fiscal spending focusing on the vulnerable and the rural economy, coupled with liquidity enhancing measures and structural reforms such as new farm and labour laws.
The quick and sharp recovery in economic data was already evident in September and early signs from October indicate continued expansion. Just as how some of the large economies like China, the US, Euro Area and Brazil exhibited a quick recovery with PMIs moving into the expansion zone after one – three months of contraction, India’s own manufacturing PMI first returned to expansionary territory in August and then sharply bounced in September to an eight-year high.
What’s more, this improvement in the economic data for September was across the board, with a significant number of growth indicators moving into the expansion zone. Power demand, e-way bills, GST collections, rail freight, exports, and auto sales have turned positive on a YoY basis. Encouragingly, data for October for e-way bills, rail freight and power demand has continued to expand.
As we parse through the data, we think that the underlying growth momentum suggests a broadening of the recovery, with domestic demand indicators improving and forward-looking data points showing encouraging signs. The PMI new orders index expanded for the second consecutive month and surged to its highest since March 2012, indicating a positive demand outlook.
We think this improvement in the incoming data and the pickup in the forward-looking indicators bode well for the growth outlook. We forecast that industrial production will turn positive on a year over year basis in September, exiting six months of contraction. As regards the overall GDP growth, we forecast a mild positive growth rate in the quarter ending in December, versus the consensus expectations of a continued contraction.
Further, early signs of improvement in the number of new Covid-19 cases also supports the case for continued normalisation of activity and a more uniform opening up of the economy. A combination of opening the economy, the resilience of the rural economy and favourable signs from the farm sector outlook, faster recovery in external demand, and an accommodative monetary policy stance implies that the growth trend should remain on track for recovery ahead.
While the timing of the inflection in its growth trajectory may differ from other economies, we believe that India is well on track to join the ranks of other economies that have seen a V-shaped recovery in growth. We expect India and the global economy to reach their pre-Covid-19 levels of output in the Q420. The risk to India is more via the inflation front where a strong recovery will bring inflation risks back to the fore at a pace faster-than-expected.
Upasana Chachra is India Economist at Morgan Stanley. Views are her own.