Global growth resilience in 2023 has been a positive surprise: Sonal Varma

Q. China announced a mega stimulus package of $112 billion. To what extent can it boost growth?

The measures from China are in the right direction, but we don’t think they are enough. A real turn in the property markets is still not visible. The main challenge is the large quantum of pre-sold homes. Consumer demand for new homes remains subdued and developers are still facing funding pressures. In addition, the economy is facing risks due to likely fading of pent-up demand and weak external demand. We expect GDP growth at around 4 percent in 2024.

For Asia, weak demand from China has been a major drag on regional exports since mid-2022. Typically, investment recovery in China has greater spillovers than consumption recovery. While we don’t expect a major growth boost coming from China in 2024, we also don’t expect further drag, given demand from China is already at very low levels. On net, we see China as more neutral for Asia’s growth for now, with Asia’s growth mainly being buttressed by a recovery in the semiconductor cycle and stronger domestic demand.

We appear to be in a sweet spot right now, with growth holding up, disinflation and prospects of policy easing around the corner. However, risks remain. First, a real recovery in China is not yet guaranteed, given cyclical and structural challenges. Second, we see weak global demand as a risk, with Euro area and UK both likely in a recession currently, and US likely to enter a mild recession in Q3 2024. Third, risks around last mile inflation remain, due to sticky wage inflation, geopolitical risks and climate change.

Q. The US Federal Reserve has signalled three rate cuts next year. How will this change the narrative for Asian emerging markets?    

Currently Asia is in a sweet spot.  There are three things that are important for the region.  One is the growth outlook itself. The region is primarily driven by exports and particularly exports of semiconductors. We are seeing early signs of recovery in semiconductor exports which will basically support some export recovery in the first half of 2024.  

Second is essentially the outlook on commodity prices. I mean we’ve gone through multiple scare factors in terms of the El Nino impact on food prices and more recently the impact on oil prices because of the Middle East tensions. Most of the countries in Asia are net commodity importers and therefore the lower commodity prices are basically positive from a terms of trade perspective.   

Third is the Fed factor. Through the course of 2022, one of the big challenges that the region faced was the capital outflow and the pressure on currency. Now, with the forward expectations on Fed changing you are beginning to see return of flows back into Asia, some in debt and some in equity. So that is helping ease the currency depreciation pressures, and therefore also helping to ease financial conditions in the region. So I think these three factors are supportive for the region right now.

Also read: How will the world economy look in 2024

Q. When we last spoke you had cautioned about growth headwinds in India in the second half of the year.  What do you think materially changed for India in the last three months?  We saw a GDP growth of 7.6 percent which beat RBI’s estimate of 6.5 percent. How sustainable is it?

That’s right. I would say growth resilience has generally been the theme for 2023. That’s true for the US, that’s true for India, that’s true for Australia, that’s true for Korea. For India specifically, a few factors (helped). One, the drop in oil prices and the broader commodity prices have actually been a positive terms of trade tailwind for India. So, if you look at corporate results, profits are growing at 20 percent even as revenue and sales growth have come down to a low single digit. This huge increase in profits, because of lower commodity prices, is definitely helping the gross value addition in terms of GDP growth.  So, I think that’s helped the manufacturing sector.   

Second, we have seen bigger than expected front-loaded capex both from the Centre and via states. So, combined general government capex has been up 35-40 percent on a y-o-y basis and that’s been actually a substantial contributor to GDP growth.  

Third, I think the global growth resilience in general has actually been a positive surprise to us. So, I mean as a house we were expecting US to tip into a recession by now which has not played out. So, I think that has also played an important role.   

These three factors helped.  Now, when we look forward, we are still expecting the US to get into a mild recession back half of 2024 and domestically for India, we think the drivers of private demand are likely to soften.  So, while in the near term growth momentum indeed is more resilient, I think the sustainability of growth is something that still needs to be monitored.

Q. Can early rate cuts by the US Fed play down some of these concerns and act as a tailwind for global and domestic growth?

Monetary policy obviously works with long lags. So, if indeed Fed begins cutting rates in March, it’s not our base case, our base case is June, would it be reasonable to expect that it’ll immediately have a positive impact on 2024 growth prospects? From our standpoint, some of the factors like tighter bank lending standards that we are seeing in the US, take time to have a full impact. Our base case is still a recession for the US, but a recession that starts only in the third quarter of next year and should be a short two-quarter mild recession. I don’t think the US Fed cutting rates in March versus June is going to change the global outlook materially.   

From India’s perspective, if you have an environment where US rates are coming down and if US and global growth is slowing, but not completely collapsing, then that can be an environment where investors look for better opportunities to put their money to work and countries which offer better growth opportunities can still attract more capital. So, at the margin, if the Fed indeed does pivot in March, then from EM standpoint that does become a positive from a financial condition standpoint.  

One of the factors of why we are expecting the moderation is essentially the timelines of the election cycle. Typically, in the run-up to elections we do tend to see a slowdown in project awarding activity and that can be a period of four-five months. Since public capex has been such a big driver of growth, that essentially means that there will be a moderation.   

It has been a big debate [whether] private capex is picking up or not picking up. Our analysis shows it’s not yet a broad-based recovery. And into the elections we don’t think the private capex cycle will turn decisively higher either.   

The third factor we have in mind is essentially the rural economy. This is not new. We have seen rural being more subdued for various reasons for over a year now and the increase in food prices we are seeing in India right now typically does tend to have more of an adverse impact on lower income households. That is essentially weighing on rural incomes and is still playing out.   

Some of the factors that we are thinking about in terms of the drivers of growth are not directly linked to what the Fed does.  So, at this stage I don’t think we see an upside risk to 2024 on the back of that. 

Q. Do you see a higher possibility of RBI lowering the repo rate before August?

 I mean our view is RBI will be driven by domestic factors. Core inflation in India has moderated to 4.1 percent in the latest reading and our view is in the next 12 months it’s going to stay aligned around 4 percent. So, we are in a very, very comfortable position as far as core inflation is concerned. The big challenge obviously is dealing with all the food price shocks which are ongoing and currently based on the food data, it does look like headline inflation will be in the 5.5 to 6 percent range for the next three to five months even as core stays anchored around 4 percent.   

So, for the MPC, which is more focused on headline inflation targeting, it would be essentially a challenge to support growth with headline inflation where it is right now. But if the growth signals start to soften March onwards and core stays aligned at 4 percent then I think the monetary policy makers have to be forward looking and they cannot focus just on where spot inflation is.   

So, as you said, I think base case is August, but we do think that risks are skewed towards earlier cuts and that risk is actually not so linked to Fed or the political cycle. It’s based on our judgment that growth will soften and the MPC could be more forward looking at some point in time.

Also read: We do not wait for the house to catch fire and then act: RBI Governor Shaktikanta Das

Q. There are mixed signals on domestic capex and you said it is not broad-based. What are the challenges?

We do feel the sentiment is quite positive on India within India. From the feedback we get from interactions with offshore corporates and institutional investors, there is actually a lot of optimism around India’s medium-term growth prospects. So, I think as far as confidence is concerned, it’s very high and, you know, the question is when do we start seeing this essentially convert into either actual FDI flows coming through or more capex being put to work. So, that’s what we are waiting for.   

One would suspect it’s a matter of time before you see some of these things pick up. There are very few countries that do offer a strong growth environment. Companies are looking to relocate their supply chain away from China.  So they are looking for new destinations and there are few big countries which also have the right investment climate. So, I think India has everything going for it. These things take time to execute. Shifting supply chains is an expensive process.  It takes time.   

FDI is determined not just by the growth prospects in India, but also by the financial situation of MNCs.  So typically, for instance, we have seen companies put less FDI money across the board in the recent quarters because the global financial conditions were essentially more on the tighter side. So, there has generally been a slowdown. So, nothing India specific.   

Q. How do you see domestic consumption pan out?  It seems to be pretty much a K-shaped recovery so far...

Our view is it’s still quite skewed and there are quarterly fluctuations depending on what data one looks at, but we don’t think rural [demand] has picked up yet. We don’t have very good data on jobs, but the rural wage data that we have does suggest that non-agricultural rural wages are growing at a relatively slow pace. So, that’s why rural demand has been more subdued, and urban has done much better and particularly the higher end consumption has continued to outpace urban consumption in the lower income quartiles.  

The one change that we are seeing is from the RBI raising the risk rates on bank lending to NBFCs and on unsecured loans. Our expectation is that because of these norms there should be some moderation in credit growth to these sectors (bank lending to NBFC and unsecured loan). This particular credit pie was growing at something like 25 percent on a y-o-y basis. Our view is because of these tightening norms you will see growth moderate to a more sustainable pace of maybe around 15 percent or so.   

At the margin, maybe in 2024, we see some moderation in urban consumption. But urban should still do relatively fine compared to rural. So, on net, I think, consumption for India has lagged investment, and within consumption, rural has lagged urban. Our view is the K-shaped consumption recovery will continue.