This guest commentary was written by Daniel Lacalle.
India’s economy had an annual growth of 5.0 percent in the April-June quarter, the slowest in more than six years dragged down by weak consumer demand and private investments.
A Reuters poll of economists had forecast annual growth of 5.7 percent for April-June, compared with a 5.8 percent rise the previous quarter. For April-June 2018, India reported 8 percent growth.
Last year I commented about the risks for India here.
Governments always consider that economic problems come from lack of demand, and they assign themselves the task of “correcting” that wrong assumption by massively increasing deficits and using monetary policy well beyond any logical measure.
India’s rising populist policies are part of the nation’s current problems.
Recent data is quite concerning.
Industrial production, manufacturing PMIs and growth estimates are coming down (according to Focus Economics).
According to Kotak Economic Research, India’s current account deficit is forecast to be the highest in six years. The overall balance of payments is moving into larger deficits than expected, as capital inflows weaken and are unable to current account deficit.
Another warning comes from the maturities in foreign exchange.
Nearly $220 billion of short-term debt, equal to more than half of India’s foreign exchange reserves, will come up for maturity in 2018-2019 fiscal year. Moody’s states that India is one of the countries that are least exposed to a rising US dollar. However, Moody’s did not expect the rupee to fall this much.
The average maturity of debt is close to 10 years and over 96 percent of it is in the local currency, according to Moody’s. However, it also notes the country’s low debt affordability. Given that the vast majority of debt is in the local currency, the incentive to depreciate the rupee is very high.
Foreign exchange reserves remain acceptable but can fall rapidly. Foreign exchange reserves are likely to suffer another dip as the rupee falls against the US dollar.
At the same time, 68% of the fiscal deficit target for 2019 consumed in the first quarter.
India expects a fiscal deficit of 3.3% of GDP in 2018-19 that seems quite challenging, given the weakening of data and the rise in expenses. The deficit was revised up to 3.5% of GDP in 2017-18.
The combination of wider trade and fiscal deficits added to lower reserves makes the currency weaken severely. The rupee keeps plummeting to new lows vs the USD.
India’s government usually solves this equation increasing subsidies and raising taxes. That combination will not work in a world that has a lower tolerance for fiscal and trade imbalances and a risk-off scenario. Additionally, the tax wedge is already a high burden. As Prateek Agrawal notes, “if one looks at GST and taxes on the affluent sections, India would rank as one of the highest taxed countries globally. For consumption, these sections are actually paying close to 60 percent of the income as taxes).
Additionally, printing more rupees is not going to solve the challenges.
The situation in India is not as desperate as in Turkey or Argentina, because FX reserves are not being depleted at a high rate, but the trend is concerning and the outlook for growth, trade and fiscal balances is weakening.
The government has preferred to raise taxes and increase spending, and the demonetization policy was a big mistake (read). All the cash that was taken out of the system came back a few months later. It is time for India to change its historical policies of subsidizing the low productivity sectors to penalize the high productivity ones with more taxes.
India can easily navigate this turmoil if it changes some misguided demand-side policies. The question is, will the government do it? Or will they prefer to blame an external enemy and increase the imbalances?
If the government decides to ignore these issues, India could become a big risk in emerging markets.
EDITOR'S NOTE
This is a Hedgeye Guest Contributor note written by economist Daniel Lacalle. He previously worked at PIMCO and was a portfolio manager at Ecofin Global Oil & Gas Fund and Citadel. Lacalle is CIO of Tressis Gestion and author of Life In The Financial Markets, The Energy World Is Flat and the most recent Escape from the Central Bank Trap.
