Key drivers have sustained the strength of our recovery

Thee strong momentum across high-frequency growth indicators corroborates our hypothesis of a constructive growth outlook for India both in the near and medium terms. Indeed, the print for gross domestic product (GDP) data for the fourth quarter of FY23 came in above expectations, with a strong set of internals, leading to an upgrade in consensus estimates for FY24. In our view, India is on track to deliver GDP growth above 6% over the next two years, while also emerging as a key driver of global growth.

The current recovery is being driven by a confluence of favourable cyclical and structural factors. Stronger balance sheets across all economic agents and improving macro stability through lower inflation and a smaller current account deficit, which reduces pressure on policymakers to tighten their monetary stance and institute structural policy reforms, are the key drivers that sustain this recovery’s strength. Against this backdrop, we discuss where we are in the growth cycle and the factors facilitating a robust growth trajectory going forward.

On the consumption front, lower household debt relative to per-capita income along with a healthy trend in labour market conditions and concomitantly improving consumer sentiment lend support to urban demand. Moreover, the moderating trend in inflation and a subsequent anchoring of inflation expectations augurs well for rural consumption, through improved consumer purchasing power. We opine that the wedge between rural and urban consumption will narrow this fiscal year, ensuring a broad-based pick-up.

The second critical driver of India’s growth is capital expenditure. Deleveraged private-sector balance sheets, targeted supply-side policy measures and a strong government impetus to public capex have set the stage for a long-term capex upcycle. The last few years have witnessed an improvement in the quality of government spending, with a steadily rising share of capital expenditure relative to revenue spending. Furthermore, improving business sentiment and investor confidence augur well for the crowding-in of private investments as well. Indeed, green shoots of a capex pick-up are visible in high frequency data, with the capacity utilization rate tracking above its long-term average and new private investments (adjusted for inflation) near their highest since 2010 in the quarter ended March 23. Capital spending assumes significance in the context of its large multiplier impact on growth and employment opportunities across sectors.

Within exports, services exports driven by resilience in IT exports have defied a trend of weak global growth, recording a double-digit uptick. We anticipate this buoyancy in services exports to continue, with a stronger growth momentum than shown by goods exports.

The aforementioned factors support our constructive outlook on India’s growth story, as we expect all cylinders to fire, ensuring a broad-based improvement in growth fundamentals. We thus view a robust growth trend, as we peg GDP at 6.2% and 6.5% for FY24 and FY25, respectively.

An important contributor to this secure macro-economic outlook is the benign trend in macro-stability indicators for the current and following fiscal year. In April, the headline Consumer Price Index (CPI) inflation was at an 18-month low of 4.7% year-on-year (YoY), while the Wholesale Price Index went into deflationary zone, with a 34-month low WPI inflation reading of -0.9% YoY, even as our trade deficit touched $15 billion, a 20-month low.

In our analysis, India’s macro stability indicators will improve in FY24. A combination of improving terms of trade (lower commodity prices than the previous year), a healthy growth mix (more capex driven), support from an improving export market share and normalization in real rates will drive this improvement.

Our headline CPI projections stand at 5.2%YoY for F24 and 4.8%YoY for F25, well within the Reserve Bank of India’s prescribed target band. The key risk to track in the near-term emanates from idiosyncratic weather-related shocks from El Nino, which can have possible ramifications on food inflation. On the external balances front, we expect the current account deficit to narrow considerably to around 1.1% of GDP in F24 and 1.5% of GDP in F25, within the policy-makers’ comfort range. Risks may emerge from an adverse terms-of-trade shock.

In our view, macro-stability tailwinds imply that monetary policy can be taken to have pivoted, though policy rates are likely to remain on hold in 2023. Thereafter, we expect a shallow rate cut cycle (of cumulative 50 basis points) from the last quarter of FY23. This allows us to assume real rates will track in positive territory, which bodes well from the macro-stability point of view.

While India’s growth outlook remains encouraging, we must closely watch domestic and global macro-economic developments for anything unforeseen. We see risks evenly balanced, stemming from cyclical and external rather than domestic or structural sources. Key risk factors include weak global growth impacting export demand and thus business sentiment, global financial conditions impacting risk sentiment and capital flows, commodity prices impacting macro stability indicators, and finally, weather-related vagaries impacting India’s growth-versus-inflation outlook.

Upasana Chachra is chief India economist, Morgan Stanley.