GST rollout & rupee appreciation drag
In the last couple of months, the new tax regime, GST has provided the country with many ups and down. In this report, Deutsche Bank Markets Research, takes a closer look at the performance of rupee in the GST era.
Positive outlook
But keep an eye on GST, non performing assets and US Fed action on interest rate
What does the economy look like at the half-way mark in calendar year 2017? A review of the Indian economy by Care Ratings reveals a mixed picture with hopes for favourable prospects ahead

It is hoped that the Indian Economy will witness an improved performance with faster growth in FY18 with the impact of demonetization largely believed to be behind us. Further, growth in the domestic economy is expected to be propelled by favourable monsoons, relatively higher consumption demand, increased government spending on infra and a recovery in private investment.
Global economic conditions too have been supportive thus far with economic growth strengthening, albeit at a gradual pace, in the key advance economies and some emerging economies alike. Hence, global growth prospects appear positive although political risks continue to prevail. A review of the economic performance in the first quarter of the fiscal presents a mixed picture. While on some counts such as foreign inflows, currency, forex reserves, industrial output, inflation the performance has been encouraging to positive, for many indicators such as borrowings and trade balances there has not been a noteworthy improvement so far. This in turn leads to conclusions that the hoped for broad based recovery is yet to materialize in a meaningful manner.
1. Uptick in Industrial output
There has been favorable growth in industrial output at the start of fiscal, indicative of a likely pickup in industrial growth. The industrial output as given by the Index of Industrial Output (IIP) in April 2017, although lower than the 6.5 per cent recorded in the corresponding month a year ago, surpassed market expectation to grow by 3.1 per cent despite the high base effect. IIP grew at an average 2.8 per cent in the preceding 4 months. The growth across the various segments of IIP in April 2017 has been mixed with negative growth in capital good and consumer durable goods and favorable growth in case of infrastructure and intermediate goods. Increased government spending has been pushing overall industrial output.
The performance of the 8 core industries, which account for nearly 38 per cent of the IIP, has seen an improvement in May 2017 to 3.6 per cent from 2.7 per cent in April 2017. The growth of 3.2 per cent in core sector in the April-May 2017, is lower than the 6.9 per cent growth during the corresponding period last year (growth in this period benefitted from the low base effect) . Steel and electricity output has seen a favorable growth this fiscal, with the former being linked with higher government infra spending which started from April 1 as well as corrective action on steel imports taken last year.
Industrial output is slated to improve this fiscal with improvement in demand across segments aided by increased government spending and consumer spending on the back of good monsoons and with pent up demand (from demonetization) and fresh demand (with Seventh Pay Commission) coming into the markets. We expect the industrial output to grow in the range of 5-6 per cent in FY18.
Moderation in Inflation
There has been an easing in price levels in the domestic economy as seen from the moderation in both Consu­mer Price Index (CPI) and Wholesale Price Index (WPI). The CPI in May 2017 (2.18 per cent) dropped to its lowest level since 2012, aided by the fall in food prices.
While there has been a contraction in the growth in prices of food products, the inflation of non-food products on the other hand has only seen a marginal decline and continues to be sticky at around 5 per cent. WPI inflation too been on a near steady decline since January 2017, having fallen from 4.26 per cent to 2.2 per cent .
There is an upside risk to inflation emerging from continued sticky non-food inflation, implementation of GST, impact of higher allowances especially HRA on CPI and farm loan waivers. Never­theless, inflation is unlikely to breach the 6 per cent upper limit of the RBI.
2. Bank Deposit
There has been a decline in bank deposit in the ongoing fiscal. During, April-June 2017, growth in incremental bank deposits was (-) 1.7 per cent compared with +2 per cent in the corresponding period last year. This can be attributed to shift in investor preference from bank deposits to other financial instruments viz. mutual funds which offer higher returns. This is indicated by the increase in Assets under Management (AUMs) of Mutual Funds. As per data from AMFI, AUMs of mutual funds grew by 38 per cent in May 2017 (Rs.19.03 lakh crore) from that in May 2016.
Decline in Growth of Bank Credit
There has been no improvement in growth of bank credit, a key indicator of the underlying health and state of a country’s economy. There has been a contraction in credit growth this fiscal. Incremental credit growth in FY18 (April 2017 to June 2017) has been (-) 2.4 per cent, a further deterioration from (-) 0.4 per cent in the comparable period last fiscal. Credit growth has been negative across sectors. As of April 2017, incremental credit growth was (-) 2.4 per cent for agriculture, (- ) 2.1 per cent for industry, (-) 9.3 per cent for services and (-) 0.7 per cent for retail. The lackluster growth in bank credit reflects the subdued nature of private economic activity in the country.
3. Drop in Commercial Paper Issuances
There has been a 14 per cent decline in commercial paper issuances in the current fiscal (April15, 2017 to June 2017), from that a year ago, indicative of the lower demand for funds and in turn pace of economic activity. During April 15, 2017 to June 2017, commercial paper issuances totaled Rs.3,72,5­00 crores, Rs.60,110 ­crores less than that in April-June 2016.
Liquidity: Liquidity in the system appears to be very comfortable as witnessed by the o/s reverse repo being around Rs 2.7 lakh crore. This has kept interest rates down with the 10-years paper now at around 6.50 per cent. There would be a downward tendency going ahead assuming RBI cuts rates by another 25 bps in October.
4. Rise in Corporate Bond Issuances
There has been an increase in corporate bond issuances in the current fiscal. Corporate Bond Issuances via private placements have risen from Rs. 1,37,127 crores during April-June 2016 to 1,51,736 crores, indicating the increase in sourcing of funds via these markets by corporate. The financial companies continue to dominate the composition of these issuances.
5. Widening Trade Deficit
The country’s trade deficit has widened in the first 2 months of FY18 to the highest levels since November 2014, driven by robust growth in imports and modest growth in exports. The trade deficit has increased by 157 per cent compared with April-May 2016, while imports have risen by 41% and exports by 12%. The rise in imports can be attributed largely to the increase in imports of precious metals (that has risen by over 220 per cent) and petroleum products (29 per cent increase). Persistent high trade deficit could pressure the rupee.
6. Upsurge in Foreign Inflows
Foreign Portfolio Investors (FPI) inflows in Indian capital markets during April-June 2017 have been $12 billion, compared with the outflow of $3 billion in 2016. There has been a surge of foreign inflows into Indian markets since February 2017 on improving sentiments for the Indian economic potential along with favorable interest rate differentials (compared with other markets) and a relatively stable currency (the RBI has been foreseeing sharp movements in the Rupee).
Although, FPI interest in Indian markets are likely to be sustained, there could a tempering of inflows in coming months viz. after the US Fed raises interest rates again and starts reduction of its balance sheet, which would have implications on liquidity and thereby on the flow of funds . Also the pace will slacken as the FPI limits in debt are consumed after which it will have to be mainly in equities.
Strengthened Currency
The Indian Rupee continued to strengthen in the ongoing fiscal, having appreciated by 0.1 per cent since April 2017 and by 5 per cent since January 2017. The Rupee is 4 per cent stronger than year ago levels (June 2016), despite the widening trade balance, decline in software receipts and remittances. The increased inflows from foreign portfolio investors (FPI) since February 2017 into the Indian Capital Markets have primarily aided the appreciation of the Rupee.
Although, the FPI inflows would continue given the underlying advantages the country possesses, there could be a moderation in the same following the US Fed Reserve actions. This coupled with the weak Balance of Payment Fundamentals (remittances, software receipts & trade balance), could result in the Rupee depreciating towards Rs.66-66.5 per dollar by the end of FY18.
Buildup in Forex Reserves
India’s forex reserves have risen to a record high of $383 billion as of June 2017, a $14 billion increase since April 2017. This increase has been on account of the increase in Foreign currency assets of the RBI, who has been buying dollars to limit the appreciation of the rupee.
Forex Reserves for FY18 could on an average be around $385 billion.
Going forward
Although prospects for the Indian economy appear favorable the critical factors to watch out for in coming months would be:
Impact of GST. The time taken by various sectors and businesses to sort out the initial implementation issues would have a bearing on the overall level and pace of economic activity.
The resolution of the NPA problem which will have a bearing on the ability of banks to increase lending when demand picks up in the second half of the year.
Global developments on interest rate action especially by the Fed which will drive foreign flows.
RBI action on interest rates. We expect a rate cut by 25 bps in October.
Pick-up in private investment – there has been exhaustion of inventories due to the GST announcement which should lead to higher capacity utilization in future and investment at the second stage.
We expect the Indian economy to grow by 7.6-7.8 per cent in FY18.