India's Strong Economy Continues to Lead Global Growth

IMF published its annual assessment of the Indian economy and makes for an interesting read. Here are the highlights.

India’s economy is picking up and growth prospects look bright—partly thanks to the implementation of recent policies, such as the nationwide goods and services tax. As one of the world’s fastest-growing economies—accounting for about 15 percent of global growth—India’s economy has helped to lift millions out of poverty.

Following transitory disruptions, growth is projected to recover in FY2018/19 and strengthen in FY2019/20 as stability-oriented macroeconomic policies and progress on structural reforms continue to bear fruit. High foreign reserve buffers and strong FDI inflows have helped contain external vulnerabilities. Risks to the outlook are tilted to the downside. Key external risks—higher global oil prices and tighter global financial conditions— have grown in recent months, placing a premium on prudent policies. Domestic risks include tax revenue shortfalls and delays in addressing the twin bank-corporate balance sheet problems

While India has been one of the fastest-growing large economies in recent decades, investment growth has been comparatively modest and formal job growth insufficient. This creates challenges for creating jobs for a young and growing population and sustaining inclusive growth.

Important reforms have been implemented in recent years. This includes the inflation targeting monetary policy framework, the Insolvency and Bankruptcy code (IBC), the goods and services tax (GST), and steps to liberalize foreign direct investment (FDI) flows and the ease of doing business (Appendix I). A further deepening and broadening of structural reforms is needed to raise investment, job growth, and productivity over the medium term, to spur India’s catch up with advanced economies and create jobs needed for India’s young and growing labor force.

Stability-oriented macroeconomic policies and progress on structural reforms continue to bear fruit, despite transitory disruptions to economic activity.

Systemic macro-financial risks bear monitoring, nonetheless, as the weak credit cycle could impair growth and the sovereign-bank nexus has created vulnerabilities.  Bank credit growth recovered to 12.5 percent (y/y) in May. Incremental credit was mostly allocated to households and the services sector, with credit to industry remaining stagnant. The corporate sector has been deleveraging slowly and, while debt repayment capacity and profitability appear to have bottomed out, they remain weak in aggregate. The recent fraud at a large public sector bank (PSB) highlights governance weaknesses which have depressed bank share prices.

The RBI’s Asset Quality Review (AQR), initiated in 2015, improved recognition of non-performing assets (NPAs), especially in PSBs, which account for about 70 percent of the banking system’s assets. So far, 11 PSBs have been put under the prompt corrective action (PCA) framework that became effective in April 2017. Meanwhile, system-wide capital adequacy has continued to improve and remains above the minimum requirements. Nevertheless, PSBs continue to report low profitability, high NPAs, and increased provisioning, related to the reclassification of their loan portfolios, which remains a constraint on credit expansion and investment.

Financial markets were generally robust through early 2018—especially equities. Market sentiment, however, has deteriorated in recent months, in line with increased global volatility. Moreover, 10-year bond yields rose by 130 basis points in the nine months through early-March, despite Moody’s upgrade of India’s government bond rating in November for the first time since 2004.
This reflects concerns of higher global yields, that the center and state fiscal targets would be missed, and that some PSBs need to reduce holdings of government securities due to mark-to-market losses—further highlighting the bank-sovereign debt nexus. In recent months, yields have been particularly volatile given countervailing forces—announcements regarding the debt issuance calendar for the new fiscal year showing backloaded issuance and easing foreign investment limits for borrowings have been more than offset by global factors, including rising U.S. interest rates and higher oil prices

India has been affected by the emerging market turmoil since mid-April. Portfolio outflows from India were relatively large, triggered by the runup in international oil prices and tighter global financial conditions, as well as domestic concerns over fiscal slippages and the 2 PSBs raised INR 120 billion of the planned INR 580 billion in late FY2017/18 through the equity market and the sales of non-core assets.
banking system’s exposure to the sovereign. In the ten weeks since April 13, net portfolio outflows amounted to US$9.3 billion or about 0.3 percent of GDP, and pressures from significant capital outflows were absorbed through the rupee depreciating by about four percent vis-à-vis the U.S. dollar. Nevertheless, this episode of capital reversal has been less intense than the 2013 Taper Tantrum, thanks to India’s stability-oriented policies and progress with structural reforms in recent years.

The macroeconomic outlook for FY2018/19 is broadly favorable, even when considering the recent upward revision to global oil prices and tightening of global financial conditions

You can check out the full report here.