India to enjoy a strong cyclical rebound in 2021 but with structural challenges:Natixis

NEW DELHI -- India's economy fell sharply by -9.3% in the first three quarters of 2020 due to a pre-emptive strict lockdown in Q2 2020 to contain COVID-19. Excessive dependency on services, sharp supply constraints and limited manufacturing exports did not provide respite, according to the financial services group, Natixis.

"In addition, a rather cautious fiscal stimulus did not help avoid the worst, in growth terms," the Natixis report says. "That said, the silver lining of plummeting growth is the massive favourable base effect, which will help India grow fast in 2021 by 8.7%."

The report said a decline in demand, and thus imports as well as monetary easing through rate cuts, quantitative easing and regulatory support, have helped turn India's current account into surplus and eased financial conditions substantially.

"Additionally, the Government change of strategy on COVID-19 by avoiding costly lockdown even as the virus spiked in Q3 2020 also helped the recovery. Moreover, cases have declined steadily since then, which have sharply improved mobility and thus growth. This is already clearly seen in data such as the PMIs and imports, both expanding rapidly and amongst the best in Asia."

Natixis says India's budget unveiled on February 1 for the fiscal year 2022 (Q221 to Q122) showed the Government will continue to support the recovery through sharp increases for capital expenditure of 26% while refraining from raising taxation.

"The focus to increase infrastructure spending and ease import duties for infrastructure-intensive commodities, such as stee,l shows a strong commitment to target higher quality spending.

"Beyond capital expenditure, health took priority with INR2.2trn spending, which should pay off as India is ahead of emerging markets in vaccine acquisition and distribution. While estimated borrowing declined on a %YoY basis, it was still higher than pre-COVID at INR12trn.

But, the report warns, beyond the sharp cyclical rebound, concerns regarding India's medium-term prospects remain.

"First, the recovery in employment is uneven, which points to the lack of structural growth engines, particularly in the manufacturing sector, which is very much needed to absorb India's woefully-underemployed labour force.

"Second, while system-wide liquidity improved, credit growth is sluggish and remains constrained due to an undercapitalised banking sector with rising NPL that is masked by regulatory support.

"Finally, India still lacks the ambition to expand outward and attract manufacturing FDI, as it has not negotiated any major trade deals in juxtaposition to China's RCEP - in which India did not partake - and one with the European Union.

"That said, India is showing some marginal positive change in this budget to chip away at structural issues, such as liberalising the insurance sector to FDI to 74% from 49%, as well as creating a fund to deal with bad debt and INR200bn to recapitalising state banks.

"Reducing import tariffs, especially for key inputs for much-needed infrastructure, is also helpful. Recent labour market reforms as well should help. Still, much more is needed for the multitude of challenges."

www.researchasia@natixis.com  (ATI).