Exclusive | Nomura’s Sonal Varma expects weaker growth, moderation in inflation in second half of 2024

Outlook for India

Our outlook for FY25 and CY24 is that it's going to be a year of a strong start but weak finish. There will be a softening in the growth momentum in the latter half of this calendar year. First, the big push on public capex has been frontloaded, and as the election cycle gets ongoing, there'll be a moderation in public capex awarding activity.

Second… urban discretionary demand, which has been quite strong and partly driven by the drawdown in savings, still remains quite strong. There's been some tightening in macro prudential norms in terms of lending by the RBI, which at the margin will mean some moderation in urban consumer discretionary demand.

Third, global factors. Our house view is that the US recession is delayed but not denied. In the second half of the calendar, we are looking for the US to slip into a mild recession. If that plays out, there will be some spillover on India, particularly on the services side of the economy.

Challenges for consumption, government intervention

Private consumption has been a disappointing aspect of the composition of India's growth recovery. The rural side of consumption, in particular, has been quite weak. Rural derives income from both farming and non-farming activity, with non-farming activity closely tied to jobs that are being created in construction, manufacturing, transportation and related sectors. On the farming side, the cost of production has been relatively higher compared to the output or the returns that farmers have got. On the non-farming side, job creation is probably not happening at the right pace.

When we look at rural wages on an inflation-adjusted basis, real rural wages have actually been quite tame. Typically, if you look at the distribution of savings between urban and rural consumers, the savings rate usually is lower at the rural end of consumers. While urban consumers have higher savings, which they've drawn down to partly consume more, that excess savings or savings is not as much of a buffer for rural India. Terms of trade for the rural economy have been under pressure because of a mix of all of these factors.

Also read: Faster-than-expected GDP growth in FY24 driven by government activism: Nomura

Over the next 12 months, India’s inflation will gradually fall. Over the last one year, while we've seen core inflation come down, food inflation, which actually has a higher weight in rural expenditure, has been volatile, but mostly on the higher side. On average, we've seen inflation closer to 5.5 percent.

Compare that to the next 12 months. If we don't get any major shock around food prices, then on average, inflation in FY24 and FY25 should be closer to 4.5 percent, driven both by sustained moderation in core inflation as well as food inflation. From a real income perspective, some of the squeeze that consumers in the low- and middle-income bucket were facing because of higher inflation should be less of a headwind going forward. And to that extent, consumption demand from those categories should be, at the margin, better for the rural consumer.

There's some tightening on credit disbursement, particularly unsecured credit. Jobs in the IT and related space have come off. Thus, there should be some normalisation in urban demand and some rebalancing of consumer demand between rural and urban. Over the next 12 months, on aggregate, consumer demand should be flat to marginally lower compared to the previous 12 months, but broadly stable.

We are not expecting any major government intervention at this stage. There are, of course, particular segments of the population that the government wants to focus on – farmers, for instance. And those specific targeted interventions could come through, but not a broad-based consumer focus.

Merchant exports

We went from a period of excess demand post-Covid to excess supply all across the world. And we've seen in a number of sectors, a period of inventory correction cycle which has weighed on goods demand globally.

Very high inflation in the developed world has also depressed demand for goods and that has weighed on the global trade cycle. For instance, while the US economy has been resilient and avoided a recession (so far), the goods cycle has gone through recessionary conditions, and that has weighed on exports for a number of big exporting countries, including India.

This inventory cycle has played out – now, inventories are more lean across a number of sectors. Inflation is also coming down in developed economies. Real incomes are picking up and you're seeing some stabilisation in goods demand in the advanced economies, which is the reason we think that there are early signs that the goods cycle is bottoming out. For India, that should mean that going forward, we're sort of moving from a period of deep contraction in exports to a period where, potentially, we could move into positive territory.

We need to monitor two risks though: one is the Red Sea disruptions on the shipping side, where the economic impact really depends on whether this is a short-term or a more prolonged disruption. It could cause some short-term hiccups on trade. Second is the broad strength of demand in advanced economies. If the US does slip into a recession in the second half, which is our house view, this export cycle could end up being more short-lived.

Also read: Nomura sees 12% rise in Nifty this year on strong macros, easing inflation, better earnings

Fiscal deficit and capex

We think the government will meet the 5.9 percent fiscal deficit target. The big focus for the government in this budget will be on specific electoral categories: more allocations on rural, agriculture, for farmers, for women, for youth, low cost housing, etc.

Capital expenditure has already been ramped up quite significantly over the last two to three years. We think that the momentum on capex will be maintained in FY25, but at a slower pace compared to the last three years.

And therefore, on net, we think FY25 fiscal deficit target should be brought down to around 5.3 percent of GDP, about 60 basis points in terms of consolidation, with the objective to get to the medium term target of 4.5 percent in FY26, or at least as close to it as possible.

In terms of capex, for FY25, we're building in roughly around 15 percent in terms of increase compared to FY24, where it was set at over 30 percent.

What to watch in Budget 2024

The takeaway from this budget is going to be how the government balances pre-election pressures versus fiscal consolidation. All this increase in allocation towards low-cost housing, farmers, women, youth, etc., is obviously going to come at a cost plus. We need to maintain the pace of public capex because private capex hasn't picked up. And in that environment, we still need to consolidate our fiscal finances. The government's ability to balance that while ensuring fiscal consolidation should essentially be the main takeaway.

Possibility of RBI rate cuts

The biggest positive for India is the moderation in core inflation that we have seen – 3.8 percent in December. For the next 12 months, we do think core inflation will stay below 4 percent as well. And headline inflation will also be averaging around 4.5 percent. If that happens and if growth moderates in the second half of 2024, that will be the trigger for the RBI to move. Because implicitly, at 6.5 percent, the real policy rates will be close to 200 basis points, which is on the more restrictive side.

For us, the RBI will sequence the monetary policy exit starting with a change in stance to neutral, which could come through as early as April, followed by actual repo rate cuts, which we are currently building in from August onwards. And for FY25, cumulatively we have 100 basis points in cuts. So that should take the repo rate down to 5.5 percent.

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