Economy

FACTORS THAT WILL SHAPE THE INDIAN ECONOMY IN 2019

Global economy headwinds

As we proceed further into 2019, a degree of uncertainty clouds the economic

outlook, however growth and confidence are expected to pick up during the year.
China, the world’s second largest economy, slowed in the second half of 2018, which
was a contributor to the weak performance of global stock markets over the year.
Financial conditions in the US also tightened in 2018, not through the channel of 10-
year treasury rates, but via rising spreads of corporate debt, higher value of the
dollar, and falling equity prices in the final quarter of 2018. We expect this financial
tightening to reduce US GDP growth in 2019 to 2.4% from 2.9% in 2018.

Slower US growth in 2019 will have a positive side as well.

It will ease pressure on the tight labour market, keeping inflation down. It will also
ease the Fed’s need to increase short-term rates, which will take off some upward
pressure of the dollar – providing some relief to emerging markets and US exporters.
Finally, as a 2020 US election is in the offing it may also motivate politicians to reach
a deal with China on trade.

China at its end, is already deploying extra fiscal stimulus to boost its economy, as
the government seeks to boost consumer spending while reducing reliance on exports
and leveraged fixed capital investment for GDP growth. Growth is also expected to
pick up in Europe, and upside potential for the euro area economy in 2019 include
lower oil prices, a bounce back of the German economy, increased government
spending in many European countries and a Brexit compromise (in all likelihood
leading to an orderly exit of UK from the EU).

India growth story

India’s GDP growth moderated in the quarter ending December 2018, touching 6.6%,
as compared with 7% in the previous quarter, due to weaker consumption and
liquidity constraints, fuelled by the NBFC liquidity crunch which emerged towards the
end of 2018. Still, the GDP growth outpaced neighbouring China's 6.4% growth in the
same period, with India retaining the status of the world’s fastest growing major
economy. Also, while the country progresses into the election season in mid-2019, the
recent escalation of tensions between India and Pakistan and the response around the
escalation might have put the current government on a steady path of re-election.
This could spell positive news for the equity market and investment inflows.

In October 2018, the International Monetary Fund (IMF) had reduced India’s GDP
growth forecast to 7.4% for 2019 compared to the previous forecast of 7.5%. This was
largely due to a volatile global economic backdrop. However, in January 2019, India’s
growth forecast for 2019 has been revised upwards to 7.5%, even as it cut the same
for the global economy by 0.2% at 3.5 per cent for 2019 (Figure 1-1). This will ensure
that India remains the world’s fastest growing major economy. The IMF’s database
also suggested that India’s contribution to world growth has increased from 7.6%
during 2000-2008 to 14.5% in 2018.

In October 2018, the International Monetary Fund (IMF) had reduced India’s GDP
growth forecast to 7.4% for 2019 compared to the previous forecast of 7.5%. This was
largely due to a volatile global economic backdrop. However, in January 2019, India’s
growth forecast for 2019 has been revised upwards to 7.5%, even as it cut the same
for the global economy by 0.2% at 3.5 per cent for 2019 (Figure 1-1). This will ensure
that India remains the world’s fastest growing major economy. The IMF’s database
also suggested that India’s contribution to world growth has increased from 7.6%
during 2000-2008 to 14.5% in 2018.

Figure 1-1: GDP growth rate

Source: IMF, January 2019

Figure 1-2: Key interest rates

Source: Database of Indian Economy, Reserve Bank of India (DBIE - RBI), January 2019

Interest Rates and Inflation

In the wake of the continued drop in inflation and improvement in domestic macro-
economic sentiments (despite growing global trade protectionism and an uneven
growth outlook), the RBI maintained the repo rate stable in the last quarter of 2018,
while opting for a rate cut in February 2019, the first since August 2017 (Figure 1-2).
Also, the Monetary Policy Committee (MPC) decided to change the monetary policy
stance from calibrated tightening to neutral keeping in mind the medium-term target
for CPI of 4% within a band of + / - 2%, while supporting growth. As core inflation
(excluding fuel and food prices) which in the past was sticky, has also started to ease;
hence there is expectation of another rate cut in April 2019.

According to the RBI, India’s inflation outlook will be shaped by multiple factors,
including softening crude oil prices, and the volatile international financial markets.
Inflation is likely to edge over 4% in the second half of the next fiscal year (we have
already seen an uptick in inflation, moving from 2.0% in January 2019 to 2.6% in
February) and there are various upside risks from volatility in food and fuel prices,
monsoon uncertainty, possible fiscal slippages and high core inflation. Against this
backdrop, it is unlikely that the Central Bank will be very aggressive in cutting rates
(Figure 1-4).

Figure 1-3: 2019 Summary of expected global fiscal and monetary policies
G7 & 2019 2019 Fiscal Policy Monetary Monitary
 BRIC's GDP Growth CPI Inflation Policy Policy now
(F) (F) Ahead

Canada 1.4% 2.2% Contractionary Tightening Neutral

France 1.5% 1.0% Expansionary Tightening Easy

Germany 1.2% 1.5% Expansionary Tightening Easy

Japan 0.8% 1.1% Contractionary Tightening Easy

Italy 0.2% 0.7% Expansionary Tightening Easy

UK 1.5% 2.2% Contractionary Tightening Easy

US 2.4% 1.9% Expansionary Tightening Neutral

Brazil 2.0% 3.5% Contractionary Tightening Tight

China 6.0% 2.1% Expansionary Tightening Neutral

India 7.2% 4.0% Contractionary Easing Tight

Russia 1.0% 5.1% Contractionary Tightening Tight

Global 2.6% 3.3% Mid Tightening Mid Easy

Expansionary

 
Source: Oxford Economics, CBRE Research, Q4 2018

Figure 1-4: Consumer Price Index (CPI) and Wholesale Price Index (WPI) movement
Source: Office of the Economic Advisor, October 2018; DBIE -RBI, December 2018; *Provisional numbers

The twin deficits – Current and Fiscal

A fiscal deficit occurs when a government's total expenditures exceed the revenue
that it generates, excluding money from borrowings. India has set a target of fiscal
deficit at 3.4% of GDP in 2019-20, however it is likely to face challenges in meeting
this target because of higher spending and lower revenue growth. The 3.4% fiscal
deficit target is wider than expected, largely driven by increased spending to provide
income support to small farmers and tax rebates ahead of the general elections in
April-May this year. In order to ensure that the fiscal target is met, the government is
trying to tap every source of revenue that it can. For instance, the Reserve Bank of
India transferred INR 28,000 crore as dividend to the government in early 2019. The
Securities and Exchange Board of India (SEBI) is also likely to transfer a large portion
of its surpluses to the government.

For next year, deviating from the path laid down in the Fiscal Responsibility and
Budget Management (FRBM) Act; the government has pegged the fiscal deficit at 3.4%
of GDP, as against the original target of 3.1%. However, as per the IMF, greater
efforts will be needed to reduce India's fiscal deficit as the interim budget envisages a
slower pace of fiscal consolidation than previously planned, thereby delaying the time
to reach the medium-term central-government debt target of 40% of GDP. To ensure
that the debt target is met by 2025, further steps to increase GST compliance will be
critical to reach budgeted revenue goals.

For India, the value of the rupee as well as crude oil and gold imports are major
factors which affect current account deficit (CAD). Given that fuel imports constitute
a larger share of India’s imports compared with other emerging markets, India is
especially vulnerable to an oil price hike, which, apart from raising the twin deficits,
would also feed into inflation.

Movement of the rupee against the dollar also has an impact on the CAD levels and a
rupee deprecation results in more expensive inward-shipments / imports (Figure 1-5).
The government on its part is taking CAD controlling measures such as reviewing
mandatory currency hedging for infrastructure, easing rules for manufacturing entities
to raise overseas funds, removal of restriction on Indian banks’ market making of
masala bonds, amongst others.

Figure 1-5: INR versus USD – exchange rate movement

Source: Bloomberg

POLICY STIMULUS

Various policy measures were undertaken in 2018, most of which were follow ups to
measures already undertaken in 2017, to ensure that the full intended benefit of
these measures was achieved. The first two months of 2019 have also been fairly
active and saw revisions in several policy initiatives as the government focused on
meeting end-user and industry expectations. The table that follows highlights the key
policy reforms undertaken by the government in recent times.

Table 1-1: Policy Initiatives

Policy Initiatives Key Highlights Expected Impact

REIT By 2018, almost all concerns regarding In Q1 2019, Embassy Group and Blackstone
the viability of a REIT launch had been Group LP launched the country's first REIT,
addressed, making it an opportune time which was oversubscribed on listing. This is a
for a REIT listing. critical step towards formalising the funding
mechanisms prevalent in the sector.

FDI in e- Towards the end of December 2018, Though the intent of these provisions was to
commerce, draft the government came out with ensure that there are no circumventions around
e-commerce clarifications on the existing FDI policy the existing policy (specially to gain entries
policy on e-commerce. Two key points that into multi-brand retail); however, some of
were enlisted in the clarifications were: these provisions are seemingly restrictive,
particularly for foreign players. While existing
To keep a tab on inventory players might have to redraw their business
ownership, a vendor can only sell 25% models / future plans; a constantly changing
of its total goods by value to a single e- policy may also impact foreign investor
commerce player. sentiment. To ensure a level playing field,
Any entity that has an equity there is a need for a comprehensive e-
participation by an e-commerce player commerce policy applicable to both foreign
cannot sell its products on the platform and domestic players.
that is run by such an e-commerce
player.
A draft e-commerce policy
was floated In Feb 2019, for industry
suggestions wherein data has been
termed as a ‘National Asset’ and a legal
and technology framework proposed
for imposing restrictions on cross-
border data flow.

GST rate cuts GST Rates - Non-Affordable Housing Having a standard tax will allow for simplicity
change in in compliance processes and should result in
definition of 5% on under-construction limited tax leakages. There could be an
affordable properties with no input tax credit increase in cost due to no ITC for developers
housing (ITC), no GST on completed projects (particularly for affordable housing projects),
GST Rates - Affordable Housing however this could be offset by an increase in
sales volume.
1% on under-construction
property with no ITC, no GST on
completed projects

Amendments in Revisions to the ECB policy were The move is likely to improve the Ease of
RBI’s ECB made in January 2019, wherein all Doing Business ranking. Also, to curb the
(External eligible borrowers have been allowed volatility in the forex market (because of
Commercial to raise up to USD 750 million per increasing demand for the USD for crude oil
Borrowings) financial year under the automatic purchases), the revised norms provide special
policy route, replacing the existing sector-wise allowances to public sector oil marketing
limits. The Central Bank has also companies.
expanded the list of eligible borrowers
and recognised lenders.

Affordable Change in definition of affordable Relaxing the carpet area for affordable housing
Housing housing: means that a significant majority of the
country’s residential stock now falls in the 1%
60 sq. m. in metropolitan GST category (higher in tier II cities, lower for
cities (NCR including Delhi, Noida, the major tier I cities), which will augur well
Greater Noida, Ghaziabad, Gurgaon for the government’s programme of building
and Faridabad), Bangalore, Mumbai – housing for all by 2022.
MMR region, Chennai, Hyderabad and
Kolkata) having value up to INR 4.5
million
90 sq. m. in non-metropolitan
 cities / towns with value up to INR 4.5
million.

Angel tax The government shall now Widening the definition of start-ups (which
consider an entity as a start-up for up to now includes later stage companies, with a
10 years after its incorporation as higher annual turnover), increasing the
compared to 7 years earlier; its exemption limit on equity investments will
turnover for any one financial year has give the much-needed boost to mid-sized start-
not exceeded INR 1 billion. ups.
Start-ups can apply for an
exemption from angel tax if their paid- The earlier regime has numerous redundancies,
up share capital is up to INR 0.25 stretched timelines, and red-tapism due to the
billion, compared to INR 0.1 billion procedures, which will now be reduced. It will
earlier. provide a conducive environment and enable
quick processes.

100% risk In Feb 2019, the central bank The proposed merger of existing categories
weights removed announced that NBFCs’ risk weights would reduce, to a large extent the
for Non Banking will now be as per their rating, which is complexities arising from multiple categories
Financial a positive development for higher-rated and also provide NBFCs greater flexibility in
Companies NBFCs. Also, various categories of their operations.
(NBFCs) NBFCs have evolved over time
pertaining to specific sector / asset
classes - at present there are twelve
such categories. However, it has now
been decided to harmonize major
categories of NBFCs engaged in credit
intermediation, into a single category.

Foreign As a part of the review of the FPI The removal of restrictions on FPI will
Portfolio investment in corporate debt encourage a wider spectrum of investors to
Investors (FPI) undertaken in April 2018, it was access the Indian corporate debt market.
restrictions stipulated that no FPI shall have an
exposure of more than 20% of its
corporate bond portfolio to a single
corporate (including exposure to
entities related to the corporate). The
RBI announced in Feb 2019 that the
provision stands withdrawn.

 
Source: Securities and Exchange Board of India; Reserve Bank of India, DIPP, CBRE Research

Some risks remain

While most policy initiatives have been taken with the intent to boost consumer
sentiments and attract investments, however certain policies appear restrictive,
especially policies that target the e-commerce sector. With the new draft policy that
was released in February 2019, the focus is not only on trade but also places
restrictions on cross-border flow of data; local presence and taxability of foreign
entities, the digital infrastructure for e-commerce, amongst others. While today, e-
commerce accounts for only 2-3% of the total retail trade in India; but as is true in
economies across the globe; it will gain traction in the coming years. Hence, rather
than only creating an environment of protecting small / medium scale players, the
government needs to prepare these players to embrace the reality of e-commerce.
Also, rather than restricting foreign players in the sector, the government needs to
formulate rules that encourage the Indian start-up ecosystem via tax incentives and
friendly equity investment rules. These foreign players need to be seen in a more
holistic fashion, rather than as disruptors. Benefits that these players bring to the
table - investments in technology and modern warehousing, improvements in supply
chain & logistics and widening the market base shouldn’t be ignored while arriving at
a policy that will not only impact online trading, but also have a bearing on the
overall economy.

HOW IS 2019 EXPECTED TO UNFOLD?

Even as global factors will continue to shape the economic landscape, domestic
factors such as economic growth, consumption patterns, policy stimulus, inflation and
government revenue stream are expected to a play a critical role in charting the
country’s growth trajectory (Figure 1-6). The country’s resilient domestic factors
coupled with limited exposure to global manufacturing trade is likely to result in a
largely stable pace of growth over the next couple of years. For instance, The United
States recently announced that it was ending India’s trade concessions under the
Generalised System of Preferences (GSP) as it felt that India was not providing the US
with equitable and reasonable access to its markets. However, India’s total exports
were worth USD 76.7 billion and the end to GSP affects only a small part of it -
limited to USD 5.6 billion. Household consumption on the other hand has been on the
upswing and has more than tripled in the last decade, with 28% of households
accounting for 43% of the total consumption. The trend is expected to accentuate,
with household consumption expected to triple by 2028, despite the higher base
effect.2
The government has set the stage for long-term growth with a progressive budget
which will go a long way in creation of a well-balanced and empowered economy,
with focus on key aspects such as ease of living, infrastructure, public health,
technology and better living. While paying attention to the requirements of rural
areas and agriculture, right measures have been announced for revival of important
sectors such as infrastructure, healthcare and investment. Also, stimulus is not only
from the end-user perspective, but also on the business environment front. India has
witnessed rapid strides in its Ease of Doing Business Ranking with the government
taking numerous steps in its bid to enter the top 50 ranks by next year.

Figure 1-6: Consumption growth 2018 to 2019