New Delhi: India’s economy may not get directly impacted due to the US-China trade war as it is less integrated with the global value chains, though slower global growth is likely to halt economic revival next fiscal year, says Brian Coulton, chief economist at Fitch Ratings Ltd. In an interview, Coulton said India should focus on reforms that help bring more foreign direct investment (FDI) to fund its widening current account deficit (CAD). Edited excerpts:
Fitch has recently revised India’s growth forecast for FY2018-19 to 7.8% from 7.4%. That makes you the most optimistic among the forecasters. What makes you so optimistic?
It is mainly because of a bounce-back from some of the earlier disruptions of demonetization and GST (goods and services tax) introduction. Partly it is because of the arithmetic of April-June quarter of 8.2% growth which will follow through to the annual average. There is a bit of fiscal support. There has been some progress on infrastructure spending. The investment cycle seems to be a bit stronger. We see fair amount of momentum in the economy in the short term. But if you look at the profile of our forecast, it is 7.8% in 2018-19, but then it falls to 7.2% in 2019-20.
Why do you expect a slowdown in India’s GDP growth next financial year?
We expect world growth to slow down in calendar year 2020 quite sharply. We think there will be a delayed impact on India’s growth due to the recent tightening of financial conditions and the recent hikes in the Reserve Bank of India’s (RBI’s) interest rates. When RBI hikes interest rates, you don’t get an impact on growth in 3 or 6 months, it takes 9-12 months. That explains the slowdown in our growth forecast for next year.
Indian rupee has been the worst-performing major Asian currency so far this year. Do you think RBI and the government should take more measures to stem the rupee fall or should let the market decide its level?
It seems like RBI has taken a laissez-faire approach to the currency than some other countries in the region. In Indonesia, for example, there is significant drawdown of their forex reserves. It does not seem to be a bad approach to me because India does not have a large balance sheet exposure to forex debt. The other aspect is you have a clear monetary policy framework in India. The inflation targeting is well-placed. With the inflation inside the target zone, that allows RBI a little bit more flexibility on the currency front. Of course, if the currency depreciates too sharply, then that feeds through to inflation prospects.
Should the RBI hike interest rate in its October policy review to stem rupee fall even though inflation is within permissible limits?
We do expect inflation to rise. Agriculture support prices are on the rise, there is some increase in housing rentals and weakening of the rupee—all of those things with economy remaining strong will put pressure on inflation. Our expectation is there will be further hikes in interest rates. We have in our forecast one more 25 basis point hike in interest rate by end of this calendar year. I think it is a close call whether that happens in October or December. We think RBI is on a rate-hike cycle.
US Fed is expected to continue to hike interest rates? How big a liquidity problem could it cause to India?
The reality is we are in a transition in global monetary policy. This will last for a while and it will be quite profound. We have a Fed determined to normalize policy rates. Another hike in December from the Fed, three more hikes next year and another hike in 2020 will take the US policy rate to 3.5%. So, further dollar appreciation is one aspect of it. This short-term increase in dollar interest rates is going to put pressure across the emerging market world. This will lead to tightening of global liquidity and dollar funding. That will have impact on all emerging markets, particularly those that have a funding gap and have a CAD which is not covered by long term non-debt credit inflows. As far as I am aware, India’s CAD is no longer covered by FDI. So, India relies on portfolio inflows which is sensitive to dollar funding conditions. It will be hard for India to attract portfolio debt inflows as tightening of dollar funding conditions continue. If reforms are directed to bring more FDI into the country, that will help because then, you are less dependent on portfolio debt flows.
Fitch has pared down global growth forecast over the rising trade tension between the US and China? How serious a threat could the trade war pose to global economy?
We adjusted our forecast in the Global Economic Outlook in September on the basis of the tariff threat. So it’s kind of becoming serious. The direct impact on the Chinese economy may be close to 0.5 percentage point of its GDP growth. We have downgraded our Chinese growth forecast as a result of the tariffs after assuming some offsetting policy by 0.2 percentage point. That knocks about 0.1 percentage point off global GDP of about $90 trillion. That’s a big number which cannot be sniffed at.
How will this trade war impact India?
To some extent, India is not so badly placed. India’s exports to the US and China are not massively high. Countries like South Korea, Malaysia and Taiwan are probably more tied up in the US-China supply chain than India. To the extent that the trade war lowers Chinese growth, it will put downward pressure on hard commodity prices including oil prices. And that will predominantly help the Indian economy as a net oil importer. But if the trade war slows down global growth significantly, then that is going to impact all emerging market economies including India.
India seeks to boost its exports to China and US taking advantage of the trade war; do you think that is feasible?
I am not sure how well-placed India is to step in to the areas where China sells a lot of stuff to the US such as electronics. The country that comes up most frequently in our discussions with market participants and investors to step into China’s shoes is Vietnam. Everything is already geared, it has the low value-added manufacturing base, the infrastructure, free trade zones, a lot of FDI is already there. I guess India may be a lot behind on that front. The move into low value-added manufacturing exports is an aspiration than a reality today. So, it will be hard to capitalize on the opportunity for India.
Do you think India has missed the bus of exports-led growth with the world moving away from globalization?
China will be looking towards building its relationship with other large emerging markets over the long run. To the extent India can figure out that what is that China is going to need in 10,15 or 20 years’ time as it develops and manages to penetrate its domestic market, India may benefit.