India in 2015: Stable Currency, Lower Inflation, and More Reforms

India’s private sector is optimistic about the new government’s ability to pass reforms. 2015 forecasts for the rupee have improved by more than most other emerging market currencies, money managers have poured US$16.5 billion into Indian stocks this year (more than any other emerging market), and the benchmark stock index has climbed over 35% in value.

After struggling for the past 24 months, a strong performance (5.5% GDP growth) in the first half of FY2015 has put India on the right trajectory to experience a gradual recovery in economic activity.  Still, fundamental changes (see here) will still be needed to achieve a full recovery, i.e., 8-9% annualized growth.  So what should your business expect from India in 2015?

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Expect Relative Resilience from the Indian Rupee in 2015

The Indian rupee (INR) has been one of the top performing emerging market currencies since the U.S. Federal Reserve’s announcement on tapering its quantitative easing program and plans for interest rate hikes. Given the improving fundamentals of the country, the INR is expected to remain resilient, barring  a possible modest devaluation with an average rate of 62-63 against the USD in 2015. Expectations of an interest rate hike from the Fed increases the likelihood that some capital will flee the emerging markets in search for improved U.S. yields and lower risk appetites (as seen in Q3 2013). However, in comparison to some other emerging market currencies, India’s comparatively stronger macroeconomic fundamentals should help the INR buffer itself somewhat from this flight but a small risk of depreciation will remain.

India’s current account deficit (CAD) has reduced from an enormous 4.7% of GDP in 2012, to 1.7% in 2013 and is expected to remain at a similar level or lower for the rest of 2014, given the import restrictions on gold, falling oil prices, and improving exports. Apart from the low CAD, India is experiencing a strong rebound in terms of confidence compared to some of the other large emerging markets due to positive GDP growth expectations (6.5% in 2015), reducing inflation (5.2% in October), a reform-minded government running the lower house of Parliament (the Lok Sabha), and positive risk-adjusted returns. As you know, FX movements are not only driven by fundamental but are affected by investor perceptions as well; having a Central Bank Chief dedicated to bringing inflation under control, Raghuram Rajan, and a reform focused Prime Minister, Narendra Modi, are therefore also likely to help promote confidence and optimism about the Indian market.

Decrease In Consumer Prices Finally A Real Possibility

While an average CPI of 7.7% might be considered high for most countries, in India, which has seen the CPI average at over 7% for the past 15 years and over 10% in the past 3 years, the recent decline in inflation is worthy of celebration. The CPI has steadily declined in 2014; from around 9% in January, coming down to around 5.5% in October.  India’s central bank chief, Raghuram Rajan, has remained hawkish since coming to power in August 2013, raising the interest rate three times and keeping them at a high of 8% despite calls for a less restrictive monetary policy. Rates are unlikely to be changed in 2014, but a 50 basis point cut in 2015 is expected.

Substantial increases in oil supply from the US (from shale) and slowing demand from China have caused global oil prices to fall significantly in 2014, allowing for India’s large oil import bill to reduce and ease domestic inflationary pressures. Moreover, in order to reduce its food stockpiles, the government has been drawing down on its vast rice and wheat stocks, keeping food inflation in check. The government is also more open to importing food to fill local production shortfalls and streamlining the wholesale markets. India’s perishable food inflation remains high and sticky due to the lack of appropriate supply chain infrastructure. 18% of fruits and vegetables are wasted post-harvest resulting in both sets of food items facing double-digit inflation over the past decade. The BJP government has begun work towards changing and improving centralized food purchasing processes and incentivizing investments into the supply chain.

State Election Victories Pave The Way To Easier Passage For Reforms

After sweeping up Madhya Pradesh and Rajasthan late in 2013, the BJP has gone on to not only achieve an outright victory in the General Elections of 2014 but has also won control over several large states in the legislative elections held in 2014, including Andhra Pradesh, Maharashtra, and Haryana. With the tally of its directly governed and allied states at nine and three more states up for elections in the next couple of months, the BJP is on the path to getting very close to the elusive figure of 15 – the number of states from which support is required for making constitutional changes such as those needed to introduce the Goods and Services Tax (GST) bill. The BJP is expected to attain control either directly or via a coalition in the states of Jharkhand and Jammu, which are currently going through their election processes, and is widely expected to win elections in the National Capital Territory (Delhi) elections in January/February 2015.

The BJP’s majority in the lower house of parliament allows it to pass all financial bills. However, it still requires the support of the upper house for non-financial bills. Upper house members are elected by state governments. Thus having control of a larger number of states provides the BJP a higher likelihood of gaining control over the upper house as well (a third of its seats are up for re-elections in 2016).

For making constitutional amendments, such as those needed for the GST bill, the BJP will need support from the lower and upper houses and ratification from at least 15 of the 29 states in the country. Multinational corporations should closely monitor the winter session of parliament that is currently ongoing and has 37 bills up for discussion. Key reforms to monitor are the GST, Insurance, Coal Authority and Land Acquisition bills.


FSG Clients can view the full India Post-Landmark Elections report here.

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