Can Modi pull off India's economic balancing act?

Category: Economics

Country or region: India

In this Q&A, PineBridge Economist Paul Hsiao shares his views on what the market can expect from India's government, the outlook for India’s economy, and the possible impact of a US-China trade war.


India’s macroeconomic indicators were already showing signs of weakness even before the national elections that returned Prime Minister Narendra Modi to power. As Modi’s second term begins, PineBridge Economist Paul Hsiao shares his views on what the market can expect from the government, the outlook for India’s economy, and the possible impact of a US-China trade war.

Q: Can we expect any changes with Modi’s second term? What will the government’s main priorities be?

Modi’s decisive victory was in part led by a populist economic message. In his first term, we saw reforms and an infrastructure push outweigh some missteps like the demonetization roll out. As a result, India has been one of the fastest-growing countries in the world and business cheered on the improvements at home.

In his second term, the priority is still very much the economy and regaining confidence from private businesses and households. Many economic indicators show a slowing growth momentum, a weaker labor market, and a festering liquidity crunch. The economy also faces challenging external headwinds: A more uncertain trade environment and higher commodity prices may limit the number of tools the administration has available to boost economic growth.

We believe a key marker for investors will be the announcement of the fiscal year 2019-2020 budget in July, which will highlight priorities for the administration and serve as the government’s first big test.

Q: How can the government manoeuver the economy back on track?

In the face of signs of a cyclical slowdown, policymakers have a number of tools to boost growth. The most obvious to markets would be a rate cut from the Reserve Bank of India, which should help bring down the cost of borrowing for many businesses.

The second, perhaps more difficult path is to continue with the government’s reform schedule in order to revive business sentiment and activity. Government-led schemes such as the reinforcement of the bankruptcy code and efforts to increase digital payments among the population are positive steps. Labor market reform that encourages employment of more regular workers, instead of temp workers, would also support household incomes and drive consumption growth. Furthermore, amid more trade uncertainty in the region, the government could induce foreign companies to relocate some of their production centers to India with a more competitive tax program.

Q: What downside risks should investors look out for?

One potential risk is oil prices, which still have a sweeping influence throughout the Indian economy. India is a net importer of oil and has benefitted from relatively benign oil prices in these last few years. If oil prices climb, that could put more pressure on India’s budget and currency and affect the stability of its macro outlook.

Oil Prices Have a Significant Impact on India's Economy

Oil Prices Have a Significant Impact on India's Economy

Source: Bloomberg, PineBridge Investments calculations as of 31 May 2019. For illustrative purposes only. We are not soliciting or recommending any action based on this material.

Domestically, we also see inflationary pressures rising, which threatens the likelihood of a pro-growth rate cut that some investors are expecting from the Reserve Bank of India. Furthermore, the administration has to balance expectations of supportive fiscal measures with scrutiny from bond markets regarding revenue consolidation and tighter goods and services tax compliance.

Q: How exposed is India to the global trade situation today?

Compared to the likes of China and the US, India’s economy has stayed out of any trade-related collateral damage. Part of the reason is that the US and China account for only about a fifth of total exports from India. A full-blown trade war would shave only about 10 basis points from real gross-value-added (GVA) growth in India – a relatively benign amount. The risks are higher when the Trump administration directly targets its trade relationship with India – as it has done with the elimination of India’s special trade status under the Generalized System of Preferences in May. Any other subsequent protectionist actions from either India or the US would amplify these risks.

The Impact on Growth From a 25% US Tariff on All Chinese Imports

The Impact on Growth From a 25% US Tariff on All Chinese Imports

Source: Morgan Stanley, as of 31 May 2019. For illustrative purposes only. We are not soliciting or recommending any action based on this material.

That said, India benefits from one of the best demographic makeups, a structural rise in domestic savings, and increasing prominence in global services exports. The key to supporting growth in the intermediate term is boosting India’s productive capacity through the adoption of business-friendly reforms.

Q: Could India potentially benefit from a US-China trade war?

Empirically, we have seen the likes of the US substituting imports from China and buying goods from other countries, especially when it comes to machinery and electronics. In the near term, economies like Vietnam and Taiwan may benefit from this disruption as they already have the production facilities in place to manufacture some of the goods the US used to buy from China. For India to really benefit from dislocations from this trade dispute, the government needs to keep championing key reforms to move the manufacturing sector higher up the value chain and upgrading its infrastructure in order to make it an even more attractive location for foreign businesses to consider.


Investing involves risk, including possible loss of principal. The information presented herein is for illustrative purposes only and should not be considered reflective of any particular security, strategy, or investment product. It represents a general assessment of the markets at a specific time and is not a guarantee of future performance results or market movement. This material does not constitute investment, financial, legal, tax, or other advice; investment research or a product of any research department; an offer to sell, or the solicitation of an offer to purchase any security or interest in a fund; or a recommendation for any investment product or strategy. PineBridge Investments is not soliciting or recommending any action based on information in this document. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author, may differ from the views or opinions expressed by other areas of PineBridge Investments, and are only for general informational purposes as of the date indicated. Views may be based on third-party data that has not been independently verified. PineBridge Investments does not approve of or endorse any re-publication or sharing of this material. You are solely responsible for deciding whether any investment product or strategy is appropriate for you based upon your investment goals, financial situation and tolerance for risk.

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