India: Downgrading our GDP and INR forecasts; more near-term momentum in China ::Goldman Sachs

Cutting growth forecasts for South and Southeast Asia; more near-term momentum in China
We are cutting our growth forecasts for India and most of Southeast Asia,
reflecting more difficult external funding conditions for the region as
markets increasingly anticipate US Fed “tapering” and eventual exit from
unconventional monetary policies. The largest downward revisions are in
India, followed by Indonesia, then Thailand and Malaysia. This reflects the
principle that countries with larger macro imbalances (particularly external
deficits) have faced greater financing pressures and consequently more
growth headwinds.
In India, we have cut our FY14 real GDP growth forecast to 4.0%, from 6.0%
previously, and our FY15 forecast to 5.4%, from 6.8% previously. Inflation
is likely to be temporarily higher given the effects of a weaker currency on
domestic prices. We expect the rupee to reach 72 per US dollar in 6
months’ time, recovering to 70 over a 12-month horizon.
In Southeast Asia, we have cut growth forecasts for Indonesia, Thailand,
and Malaysia between 40-70 bp each in 2013 and 2014, with a smaller
adjustment in Singapore. We reflect a stronger trajectory for the
Philippines in the first half of 2013, but also expect it to slow somewhat
next year.
Given external pressures and high inflation, we expect a further 75 bp of
policy rate hikes by Bank Indonesia before the end of the year. Inflation
and funding pressures look significantly milder outside Indonesia, and
should allow other central banks in the region to wait until mid-2014 before
hiking rates.
In contrast, the near-term outlook for China has brightened somewhat.
Growth appears to have accelerated in Q3, with signs of a pickup in
external demand and supportive domestic policies (as government policy
announcements help boost sentiment and investment) combining to drive
a turn in the inventory cycle. We now expect sequential growth of over 8%
in the second half of the year, pushing full-year growth just above the
government’s policy target.

��

--> We are cutting our FY14 GDP growth forecast for India to 4.0% from 6.0%. Consensus
estimates for FY14 by Consensus Economics stand at 5.5%. Not only has data come in
worse than expected in Q2 2013, the large negative hit to the economy from external
funding pressure since early May is driving our significant GDP downgrade. Our India
Financial Conditions Index has tightened by 100 bp since mid-July. Normally, this implies a
70 bp hit to real GDP growth. Given that the tightening tends to affect activity with a two
quarter lag, we think this hit will be visible from Q4 2013 onwards.
On the expenditure side, we see a continued decline in investment demand due to
funding issues, weak confidence, and higher interest rates. Uncertainty before the
upcoming parliamentary elections may also affect investment demand, in our view. We
forecast weaker consumption demand due to the hit to consumer confidence from the
large rupee (INR) depreciation, rising import and fuel prices, and weak employment
outlook.
On the production side, robust agricultural growth due to the good monsoons may be
more than offset by weakening industry and services growth. We reduce our industry
growth forecast substantially to -1.5% yoy from +2.7% yoy due to higher rates, funding
issues and weak confidence. On services growth, we reduce our expectation to 5.4% yoy
from 7.0% yoy as we expect construction activity, retail trade, and the consumer-related
sectors to weaken further over the next few quarters.
We have also cut our FY15 GDP growth forecast to 5.4% from 6.8%. We expect
the investment outlook to remain weak due to funding issues, weak corporate balance
sheets, and monetary policy needing to remain tight. We think consumption demand will
remain tepid next year given a weak employment outlook. We also do not see much room
for fiscal easing, given the already elevated fiscal deficit. However, we do forecast a
significant improvement in exports based on our expectation of an improving external
environment and INR depreciation.
While we are downgrading India’s forecasts significantly for 2013-2014, we remain
optimistic about its long-term potential and have not changed our views for 2015 and
beyond. We continue to believe that a rising middle class, favorable demographics, the
need for investments, especially on infrastructure, and productivity catch-up across a broad
swathe of sectors can drive growth over the medium term. Indeed, to the extent that the
sharp near-term deceleration catalyzes economic reforms, it can boost the economy’s
medium-term prospects.
In the near term, however, we see risks to our forecasts tilted to the downside due to the
negative feedback loops between INR depreciation and the banking and corporate sectors.
We think the economy is likely to need an adjustment in the current account and fiscal
balances, and may require below-potential growth for several more quarters to reduce
inflation, before we can see an economic recovery.

Inflation—higher in the near term
We increase our WPI inflation forecast to 7% from 5.2% in FY14 due to a sharp fall in the
currency, recent rise in food prices and higher crude prices. Our estimates suggest that in
the short term, a 10% INR depreciation leads to an increase in WPI inflation of about 60 bp.
Much weaker domestic demand and especially industrial activity prevents a much more
rapid increase in WPI inflation.
In FY15, we see a moderation in inflation to 5.8% due to the very weak level of domestic
demand, and activity remaining well below potential.
Monetary policy—to remain tight
We think that the RBI will likely keep monetary policy tight in the near term due to concerns
about INR depreciation. Therefore, we see short-end rates at 10.25% through December
2013 (300 bp above repo at the marginal standing facility rate). We think that monetary
policy can be gradually eased, though still much tighter than before the current measures
came into effect on July 15. We see the overnight rate moving down to 9% by end 2014
(still 175 bp above current repo), with risks that we could see more substantial easing in H2
2014 if sentiment on the INR stabilizes.
Current account—an improvement
We expect the current account deficit to improve to 3.5% of GDP (US$65 bn) in FY14,
compared to 4.2% (US$82 bn) in our earlier forecast, mainly due to recent government
measures announced to curb gold and other non-essential imports and a sharper
slowdown in domestic demand.

We see a further narrowing of the deficit to 2.8% of GDP (US$58 bn) in FY15, in part due to
higher exports as global demand recovers, still subdued domestic demand, and the
benefits of a weaker INR.
The INR—near-term pressures remain
We change our 3, 6, and 12-month USD/INR forecasts to 70, 72, and 70 (from 60 flat)
respectively. We see further real depreciation over 3 and 6 months given the challenging
external funding environment and the slowdown in GDP growth. Over 12 months, we
expect some stabilization, with the removal of election uncertainty in March-April likely to
help sentiment, and adjustment in the current account in progress. We think that there
could be some risks of near-term overshooting of our targets if economic and financing
conditions worsen, and especially if there are pressures on the banking and corporate
sectors due to weakness in growth. Our current GSDEER value for the USD/INR is at 69.3

While the economic outlook for India has deteriorated, we think that a set of policy actions
(see EM Macro Daily: India - What are the policy options? August 26, 2013), including trade
policy measures to shrink the trade deficit, tight monetary and fiscal policies, and structural
reforms can help improve economic performance.