Indian Rupee Looking Vulnerable after IMF Downgrades India Growth Forecasts by Large 0.9%

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- IMF heavily reduces forecasts for Indian growth

- Rupee could be at risk from downgrade

- Lack of available credit seen as primary cause

The International Monetary Fund (IMF) has heavily revised down Indian economic growth forecasts for 2019, with the expected slowdown in growth likely to pose negative implications for the Rupee.

The IMF cut estimates for 2019 from 7.0% to only 6.1%, and from 7.2% down to 7.0% for 2020, in its recent World Economic Outlook report, published on Tuesday, identifying the main reason behind the decline as “financial vulnerabilities” which are reducing the availability of credit.

The downward revision is one of the harshest in the G20 and although Indian growth remains relatively high, even a slowdown from such dizzying heights does not bode well for the Rupee’s medium-term prospects.

“So in the case of India, there has been a negative impact on growth that has come from financial vulnerabilities in the nonbank financial sector and the impact that has had on consumer borrowing or borrowing in the small and medium enterprises,” says Gita Gopinath, director of the research department at the IMF.

A lack of available credit seems to be the main cause of the contraction after the default of a large ‘shadow bank’ called IL&FS, or Infrastructure Leasing & Financial Services Ltd, in late 2018, which caused a credit crunch in the country.

“The common denominator in all these forecast cuts is probably the role of credit. We all talk of demand etc. but I think the latest numbers that have come out on the total flow of funds - not just banks credit - from commercial paper from corporate bonds from Non-Bank Financial Companies (NBFCs) and Housing Financial Companies (HFCs), the entire number was quite startling, dropping in the April to September period from about 8 lakh crores last year to 80,000 crores this year, a 90% drop in credit,” says Saugata Bhattacharya, chief economist, Axis Bank.

The drying up of credit from the non-bank financial sector is also the primary reason behind the pronounced slowdown in the auto sector in India where most cars are bought with money loaned from non-traditional financial companies.

Despite the negative 2019 cut the IMF was still quite optimistic in its 2020 forecasts for Indian growth, suggesting it sees a fairly rapid recovery.

Gopinath said, “Appropriate steps have been taken. There is still a lot more that needs to be done, including cleaning up the balance sheets of regular commercial banks. So, in our projections, we have that India will recover to 7 percent growth in 2020. And the premise is that these particular bottlenecks will clear up.”

The Indian government has been trying its best to make up the shortfall from the lack of private credit by increasing fiscal spending and cutting taxes such as the recent high-profile cut in the corporation tax rate from 30% to 22%.

Yet these measures have generally not been considered sufficient to counteract the broader slowdown caused by the lack of credit and global trade factors.

The credit rating agency S&P Global recently argued the fiscal measures put in place by the government could not be sufficient to avert a slowdown over the next 1-2 years.

India does not have the “deep pockets” of China to “turbocharge its economy through investment in infrastructure or pulling fiscal levers,” says the rating agency.

The government’s generous handouts are already stretching the fiscal coffers to their limit, says Bhattacharya, adding:

“There is relatively little fiscal headroom available to the government, to try counter-cyclical fiscal stimulus spending, and I think that is the underlying reason for these growth slowdowns."

The IMF is less explicit about the authorities lack of adequacy in its own assessment but does give a warning for India not to overreach itself, and that “it is important for India to keep the fiscal deficit in check.”

The World Economic Outlook report also discusses a fall in demand as a factor reducing growth in India - not just the availability of credit.

Yet it also makes the point that the government and Reserve Bank of India’s attempts to stimulate the economy may bear fruit in the future driving the 7.0% growth expected in 2020.

“Growth will be supported by the lagged effects of monetary policy easing, a reduction in corporate income tax rates, recent measures to address corporate and environmental regulatory uncertainty, and government programs to support rural consumption,” says the WEO report.

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