India will replace China as world's growth engine
Sonal Varma, managing director, chief economist-India and Asia ex-Japan, Nomura, raises concerns of a possible economic slowdown in India in the next 6-12 months as investment and consumption are likely to remain lacklustre amidst global headwinds. “Past episodes of global downturn have disrupted not just India’s export cycle, but also its capex cycle, and the lagged effects of the RBI’s rate hikes have also yet to reflect on domestic growth,” Varma explains in an exclusive interview with Forbes India.
Monsoon pivotal for government to manage inflation & growth in pre-election year
But Varma believes Asia is entering a sweet spot after a challenging year of declining exports led by semiconductors, anaemic growth in China, a steep rise in commodity prices, and unprecedented rate hikes by the US Federal Reserve. Although the near-term growth outlook is weak, Varma argues that evolving conditions are supportive for a medium-term growth rebound as exports are bottoming out and terms of trade are improving due to lower oil prices and easing inflation.
Furthermore, the veteran economist says India and Southeast Asia will replace China as the main growth drivers this decade. Unlike Western economies, Asia is likely to see a stronger and faster recovery, once global headwinds subside, due to relatively stronger fundamentals: “We believe a confluence of global push and regional pull factors are aligning and investors will look for new opportunities, place a higher premium on sustainable growth; we think Asia fits the bill,” Varma adds. Edited excerpts:
Q. GDP growth of 7.2 percent in FY23 wasn’t broad-based and there were several statistical base effects at play due to the impact of the pandemic, plus, GDP CAGR over FY19 has been only 2.7 percent. How tangible and sustainable is India's growth recovery?
From a cyclical standpoint, the next 6-12 months we see a slowdown ahead for the Indian economy. We expect FY24 GDP growth of 5.5 percent versus 7.2 percent in FY23. The higher consensus forecast appears to be underpinned by relatively muted impact from the global downturn, sustained buoyancy in services—including services exports, continued push on public capex and receding inflationary pressures. We remain less sanguine on the ability of the Indian economy to bypass the incoming global headwinds. As DM (developed market) central banks keep rates at restrictive territory, and with weaker China growth offering lesser counterbalance, we believe global growth slowdown will continue. Our US economics team is forecasting a three-quarter long recession starting in the second half of 2023. Past episodes of global downturn have disrupted not just India’s export cycle, but also its capex cycle. Meanwhile, the lagged effects of the RBI’s rate hikes have also yet to reflect on domestic growth.
Q. There are mixed signals on how domestic investment is panning out. Do you expect a durable recovery in private investment and are you seeing any on-ground evidence?
Coincident data on investment such as infrastructure and capital goods production is robust, and fixed investment demand is indeed one of the key drivers of GDP growth in FY23, led by the government’s push on public capex. Going forward, we expect weak global demand, high uncertainty and higher real rates to weigh on private capex, while a slowdown in tax collections—especially in H2 FY24—will mean public capex growth will remain in double digits but will likely rise by less than is budgeted. Hence, we are pencilling in a slowdown in domestic investment in FY24.
Also read: Why India may find it hard to buck the global slowdown
Q. The uptick in domestic consumption is uneven and skewed. Do you expect a broad-based meaningful recovery in rural and urban demand in the coming quarters?
During FY23, private consumption demand has disappointed, with urban demand doing well, and rural demand lagging behind, likely due to higher inflation and also lower savings buffer. Looking ahead, we expect rural demand to stabilise, as inflation cools down, but El Nino remains a risk to a durable recovery for rural demand, so it is a wait-and-watch for now. Meanwhile, with excess urban household savings likely drawn down already, and lagged effects of policy normalisation still to be felt, we expect urban discretionary demand to moderate going forward. Overall, we expect private consumption demand to moderate in FY24.
Q. The RBI is cautious of upside risks to inflation in the second half of FY24. How ‘sticky’ is India’s core inflation problem?
We are more sanguine on the core inflation outlook. The current stickiness in core inflation has been primarily driven by core goods. With manufacturing firms rapidly rebuilding their margins, we expect the sharp fall in the cost of industrial inputs to start being reflected in lower core goods inflation. Second-round effects—household inflation expectations and wages—remain under control, and also bode well for core inflation. The disinflationary impact from lower growth amid moderate housing inflation should lower core inflation to 5 percent in FY24 from 6.1 percent in FY23. Hence, we expect disinflationary impulses to be sustained. Overall, we expect headline inflation to average 4.7 percent in FY24, lower than the RBI’s projection of 5.1 percent due to proactive supply-side intervention by the government on food, contained second-round effects, lower manufacturing costs, softer demand and a rising likelihood of a domestic fuel price cut.
Q. Can Asian central banks such as the Reserve Bank of India decouple from the US Fed?
Asia’s divergent inflation outlook means that central banks can remain on an extended policy pause, even if DM central banks hike further. We also believe that they can cut rates ahead of the Fed. Asia’s external fundamentals have strengthened over the years, with a good FX reserves buffer that can be used to deal with currency pressures, and low inflation also giving central banks the flexibility to let the currency adjust, if needed.
This is true for India in particular, where we expect the RBI to use FX reserves to deal with currency pressures, while monetary policy focusses on inflation-growth dynamics. As the Fed pauses, domestic core inflation cools, domestic demand slows down and the current account balance improves due to lower oil prices, we expect the RBI to prioritise domestic factors over the Fed. Our view is that the rate easing cycle in India will begin much earlier than is currently expected by the consensus.
Also read: The curious case of China's confidence trap
Q. The reopening of China was a big event this year but overall recovery has been below expectations. Can it slam the brakes on global recovery?
China’s growth disappointment is not a big surprise to us. We have argued since early this year that while in-person services were likely to see a strong pent-up demand, a recovery in property investment and consumption demand was likely to underwhelm, due to weak confidence among consumers and businesses. China’s slowdown is already a big drag on global growth, but it may not slam the brakes on global recovery. But as the US and European economies slowdown in the coming quarters, China may also not provide a growth offset, which is in contrast to past slowdowns, where a big China stimulus has come to the rescue of the global economy. This time around, higher inflation in DM economies—higher for longer—and less policy space in China, means the growth recovery after the slowdown could be slower than in the previous cycles.
Q. Why and how is it Asia's time to shine when its biggest economy—China—is navigating economic headwinds?
This is a medium-term view, so beyond the expected cyclical headwinds in the coming quarters. We believe a confluence of global push and regional pull factors are aligning. During the past year, US Fed tightening and USD appreciation have led investors to focus more on EM (emerging market) risk reduction, but as prospects of subdued global growth and Fed rate cuts come closer in sight, we believe investors will look for new opportunities and place a higher premium on healthy economic fundamentals and sustainable growth. We think Asia fits the bill, since it avoided large-scale QE (quantitative easing) and fiscal expansions, leaving the region in better stead in terms of fiscal sustainability, inflation challenges and health of the financial system.
China is indeed burdened with structural challenges and geopolitical headwinds, but even with a slowing China, our medium-term [2024-28] forecasts have real GDP growth for Asia—4.2 percent y-o-y—outperforming other EMs and the US. Replacing China, India and Southeast Asia are likely to be the fastest growing economies this decade. Governments are competing with one another to attract foreign investments by improving the domestic business climate. We see new growth opportunities, such as supply chain relocations, public infrastructure spending, digitalisation and opportunities in AI and renewables.
Sonal Varma, managing director, chief economist-India and Asia ex-Japan, Nomura, raises concerns of a possible economic slowdown in India in the next 6-12 months as investment and consumption are likely to remain lacklustre amidst global headwinds. “Past episodes of global downturn have disrupted not just India’s export cycle, but also its capex cycle, and the lagged effects of the RBI’s rate hikes have also yet to reflect on domestic growth,” Varma explains in an exclusive interview with Forbes India.
Monsoon pivotal for government to manage inflation & growth in pre-election year
But Varma believes Asia is entering a sweet spot after a challenging year of declining exports led by semiconductors, anaemic growth in China, a steep rise in commodity prices, and unprecedented rate hikes by the US Federal Reserve. Although the near-term growth outlook is weak, Varma argues that evolving conditions are supportive for a medium-term growth rebound as exports are bottoming out and terms of trade are improving due to lower oil prices and easing inflation.
Furthermore, the veteran economist says India and Southeast Asia will replace China as the main growth drivers this decade. Unlike Western economies, Asia is likely to see a stronger and faster recovery, once global headwinds subside, due to relatively stronger fundamentals: “We believe a confluence of global push and regional pull factors are aligning and investors will look for new opportunities, place a higher premium on sustainable growth; we think Asia fits the bill,” Varma adds. Edited excerpts:
Q. GDP growth of 7.2 percent in FY23 wasn’t broad-based and there were several statistical base effects at play due to the impact of the pandemic, plus, GDP CAGR over FY19 has been only 2.7 percent. How tangible and sustainable is India's growth recovery?
From a cyclical standpoint, the next 6-12 months we see a slowdown ahead for the Indian economy. We expect FY24 GDP growth of 5.5 percent versus 7.2 percent in FY23. The higher consensus forecast appears to be underpinned by relatively muted impact from the global downturn, sustained buoyancy in services—including services exports, continued push on public capex and receding inflationary pressures. We remain less sanguine on the ability of the Indian economy to bypass the incoming global headwinds. As DM (developed market) central banks keep rates at restrictive territory, and with weaker China growth offering lesser counterbalance, we believe global growth slowdown will continue. Our US economics team is forecasting a three-quarter long recession starting in the second half of 2023. Past episodes of global downturn have disrupted not just India’s export cycle, but also its capex cycle. Meanwhile, the lagged effects of the RBI’s rate hikes have also yet to reflect on domestic growth.
Q. There are mixed signals on how domestic investment is panning out. Do you expect a durable recovery in private investment and are you seeing any on-ground evidence?
Coincident data on investment such as infrastructure and capital goods production is robust, and fixed investment demand is indeed one of the key drivers of GDP growth in FY23, led by the government’s push on public capex. Going forward, we expect weak global demand, high uncertainty and higher real rates to weigh on private capex, while a slowdown in tax collections—especially in H2 FY24—will mean public capex growth will remain in double digits but will likely rise by less than is budgeted. Hence, we are pencilling in a slowdown in domestic investment in FY24.
Also read: Why India may find it hard to buck the global slowdown
Q. The uptick in domestic consumption is uneven and skewed. Do you expect a broad-based meaningful recovery in rural and urban demand in the coming quarters?
During FY23, private consumption demand has disappointed, with urban demand doing well, and rural demand lagging behind, likely due to higher inflation and also lower savings buffer. Looking ahead, we expect rural demand to stabilise, as inflation cools down, but El Nino remains a risk to a durable recovery for rural demand, so it is a wait-and-watch for now. Meanwhile, with excess urban household savings likely drawn down already, and lagged effects of policy normalisation still to be felt, we expect urban discretionary demand to moderate going forward. Overall, we expect private consumption demand to moderate in FY24.
Q. The RBI is cautious of upside risks to inflation in the second half of FY24. How ‘sticky’ is India’s core inflation problem?
We are more sanguine on the core inflation outlook. The current stickiness in core inflation has been primarily driven by core goods. With manufacturing firms rapidly rebuilding their margins, we expect the sharp fall in the cost of industrial inputs to start being reflected in lower core goods inflation. Second-round effects—household inflation expectations and wages—remain under control, and also bode well for core inflation. The disinflationary impact from lower growth amid moderate housing inflation should lower core inflation to 5 percent in FY24 from 6.1 percent in FY23. Hence, we expect disinflationary impulses to be sustained. Overall, we expect headline inflation to average 4.7 percent in FY24, lower than the RBI’s projection of 5.1 percent due to proactive supply-side intervention by the government on food, contained second-round effects, lower manufacturing costs, softer demand and a rising likelihood of a domestic fuel price cut.
Q. Can Asian central banks such as the Reserve Bank of India decouple from the US Fed?
Asia’s divergent inflation outlook means that central banks can remain on an extended policy pause, even if DM central banks hike further. We also believe that they can cut rates ahead of the Fed. Asia’s external fundamentals have strengthened over the years, with a good FX reserves buffer that can be used to deal with currency pressures, and low inflation also giving central banks the flexibility to let the currency adjust, if needed.
This is true for India in particular, where we expect the RBI to use FX reserves to deal with currency pressures, while monetary policy focusses on inflation-growth dynamics. As the Fed pauses, domestic core inflation cools, domestic demand slows down and the current account balance improves due to lower oil prices, we expect the RBI to prioritise domestic factors over the Fed. Our view is that the rate easing cycle in India will begin much earlier than is currently expected by the consensus.
Also read: The curious case of China's confidence trap
Q. The reopening of China was a big event this year but overall recovery has been below expectations. Can it slam the brakes on global recovery?
China’s growth disappointment is not a big surprise to us. We have argued since early this year that while in-person services were likely to see a strong pent-up demand, a recovery in property investment and consumption demand was likely to underwhelm, due to weak confidence among consumers and businesses. China’s slowdown is already a big drag on global growth, but it may not slam the brakes on global recovery. But as the US and European economies slowdown in the coming quarters, China may also not provide a growth offset, which is in contrast to past slowdowns, where a big China stimulus has come to the rescue of the global economy. This time around, higher inflation in DM economies—higher for longer—and less policy space in China, means the growth recovery after the slowdown could be slower than in the previous cycles.
Q. Why and how is it Asia's time to shine when its biggest economy—China—is navigating economic headwinds?
This is a medium-term view, so beyond the expected cyclical headwinds in the coming quarters. We believe a confluence of global push and regional pull factors are aligning. During the past year, US Fed tightening and USD appreciation have led investors to focus more on EM (emerging market) risk reduction, but as prospects of subdued global growth and Fed rate cuts come closer in sight, we believe investors will look for new opportunities and place a higher premium on healthy economic fundamentals and sustainable growth. We think Asia fits the bill, since it avoided large-scale QE (quantitative easing) and fiscal expansions, leaving the region in better stead in terms of fiscal sustainability, inflation challenges and health of the financial system.
China is indeed burdened with structural challenges and geopolitical headwinds, but even with a slowing China, our medium-term [2024-28] forecasts have real GDP growth for Asia—4.2 percent y-o-y—outperforming other EMs and the US. Replacing China, India and Southeast Asia are likely to be the fastest growing economies this decade. Governments are competing with one another to attract foreign investments by improving the domestic business climate. We see new growth opportunities, such as supply chain relocations, public infrastructure spending, digitalisation and opportunities in AI and renewables.
