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The shocks of demonetisation and the goods and services tax temporarily hurt India’s growth, but Sonal Varma, Research Analyst at Nomura suggests that they expect a gradual cyclical recovery, with inflation rising and policy rates on hold. 

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  • GDP growth slowed to 5.7% y-o-y in Q2 2017 from 6.1% in Q1, but highfrequency data signal a recovery ahead. Consumption and services are leading the revival. Both rural (tractor, two-wheelers sales) and urban (passenger vehicle sales, consumer credit) consumption indicators have picked up sharply, as has transportation services (light, medium and heavy commercial vehicles) and the services PMI (51.7 in October from 50.7 in September).
  • Manufacturing is also reviving, but at a much slower pace as the negative effects of the goods and services tax (GST), including delayed payment of input tax credit, have continued to linger. The recently announced bank recapitalisation plan should allow banks to resolve their nonperforming asset problems, help firms deleverage their balance sheets and support a capex revival over the next 1218 months (see India bank recap: Macro and market implications, 28 October 2017). Overall, we expect GDP growth to average 6.7% y-o-y in H2 2017, up from 5.9% in H1, before rising to 7.5% in 2018.”

Inflation: CPI inflation rose from a trough in June to 3.3% y-o-y in September on higher vegetable prices, the inflationary impact of the GST and government rent-allowance increases. We expect it to break above 4% by end-2017 and continue to rise on higher food prices (cobweb cycle), a narrowing output gap and adverse base effects. The seasonal drop in vegetable prices during the winter months is yet to materialise, which along with higher oil prices could result in a higher near-term trajectory.”

Policy: The Reserve Bank of India (RBI) left the repo rate unchanged at 6.0% in October and maintained its neutral policy stance, despite lowering its FY18 growth forecast. Given our view of higher domestic growth and inflation, slight fiscal slippage, higher oil prices and a gradual normalisation of G4 monetary policy, we expect the RBI to leave rates unchanged though 2018. On the fiscal front, we expect slippage of the central government’s fiscal deficit to 3.5% of GDP from its 3.2% target given front-loaded spending and revenue losses because of the GST. The political calendar is also in focus with results of the Gujarat and Himachal Pradesh assembly elections due on 18 December.”

Risks: Higher oil prices, weaker global growth, capital outflows and lingering GST effects are the main downside risks. A stronger private capex uptick is the key upside risk.”

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