This year, the Indian rupee (INR) has been one of Asia’s worst performing currencies with a loss of more than 15% against a strong US dollar (USD). However, in spite of an INR at a record low, expected to remain under pressure in the one-year outlook, real GDP growth prospects remain solid thanks to a strong domestic demand and improved credit supply.


The INR’s negative trend follows a 6% appreciation against the USD in 2017 and takes place in a climate of shifted investor sentiment vis-à-vis emerging markets. Like many of them, India is a victim of the widening of its current account deficit. As a large net oil importer, India is vulnerable to higher oil prices. The heavier imported oil bill has been deepening India’s trade deficit whereas the gradual normalisation of US financial conditions has triggered portfolio outflows from India. As a result, the balance of payments is now in negative territory and could remain under pressure next year.

Inflation is also on a slow upward trend due to a weaker INR and higher fuel prices (even though subsidies mitigate the pass-through on inflation). However, the Reserve Bank of India’s interest rate increases (from 6% to 6.5% in 2018) and persistent low food prices should contain inflation around 4.5-5%, i.e. a relatively low level for Indian standards. The deterioration of the external economic context (including the prospect of a limited decline in oil prices), and impact on India’s domestic economic conditions and external accounts cloud the macroeconomic outlook.

Still, all those downside risks mentioned above are likely to be manageable thanks to a floating INR, liquidity buffers – with foreign exchange reserves covering more than 6 months of imports and 3.5 times the short-term debt – strong FDI inflows and a sustained domestic demand. The current account deficit is expected to be at 3% of GDP in FY 2018 before only slightly receding to 2.5% in the next FY as poor export competitiveness constrains the benefits of a weaker INR. The recent government decision to raise import tariffs on tens of ‘non-essential’ goods (e.g. electronics) is a protectionist way to stem the rupee decline and foster import substitution which should help reverse the widening of the current account deficit.

Moreover, in the run-up to next spring’s elections, the commitment to rein in the fiscal deficit will be on hold, which will tolerate a looser fiscal policy. Therefore, increased government spending and enhanced social and healthcare expenditures are likely to support economic performances. In its latest real GDP growth forecasts, the IMF expects the Indian rate to reach 7.3% and 7.5% for the FY 2018 and 2019 respectively. To reach those strong results, India’s next government – probably again Modi’s – and monetary authorities will have to improve conditions for higher bank credit growth. The latter has been rising over the past months but it is mainly benefiting the services sector whereas growth in the manufacturing sector, a key target for PM Modi, remains weak. It will greatly depend on recapitalising (state) banks and tackling banking weaknesses, chiefly bad governance and the heavy bad loans which have been gradually on the rise this year as under-reported debts are made public.   

Analyst: Raphaël Cecchi – r.cecchi@credendo.com