In your mid-year outlook, you have highlighted the resilient domestic demand when it comes to the Asia region. Which countries do you see as the most insulated from global shocks in the second half of the calendar year?
Chetan Ahya: In the region, we think India and Australia are relatively insulated and we are also constructive on Japan because Japan story has essentially been the one of reflation, i.e., that they have been sort of moving out of deflationary environment to more moderate inflation environment and we think that that story is relatively intact. It is also supporting their domestic private consumption with wage growth picking up and supporting domestic demand. We are constructive on India, Australia, and Japan to the extent to which it has support from domestic demand as well.
Let us talk about India then. Since you have revised your growth trajectory when it comes to India upward, what are the key drivers sustaining this momentum despite the global headwinds and that big overhang of tariffs?
Chetan Ahya: India’s major relative advantage is that its goods exports to GDP is just about 12% and for the rest of the region, it is in the range of like 20% to 50%. India is relatively insulated to the extent to which its exposure to global goods trade cycle is much lower than everybody else and at the same time, it has this structural domestic demand story which is also much stronger than the rest of the region and this is coming in from the fact that the government policies are very focused on pushing in investment.
If you see the trajectory of the Indian government, both centre plus state taken together, revenue expenditure versus capital expenditure both the lines are moving in the right direction. Over the last five years, we have seen a consistent decline in revenue expenditure to GDP and that has been taken as an opportunity by the government to increase its capital expenditure to GDP and that is what we needed right.
We have the right demographics but what we need is the right policy environment that is focused on boosting investment and job creation, so that the government focus on boosting investment has also sort of been a key driver of India’s strength in domestic demand. A factor that has been underappreciated is the strength in services exports. I know at some point of time you will probably see some slowdown in services exports for India too, but to the extent to which a part of this gain in services exports growth is because of market share gain and in the backdrop a big expansion in the addressable market post Covid where there is a general perception that has been going around in countries like the US that if you can work from home, you can work from Bangalore, and that sort of led to a major expansion in the addressable market for services exports and then India is also gaining market share in that growing addressable market.
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So, both those factors have kept the resilience in services exports. Last month, services exports grew by 17% on a year-on-year basis. We think that the India story has been buffered by the structural strength in domestic demand and resilience in services exports.
How does a divergent monetary policy path in Asia and pretty much all across versus what the US Fed is doing? Does that really pose a risk or an opportunity? Does it really create more capital flows into India?
Chetan Ahya: We think that yes, it could have been even a constraint for Asian central banks to cut rates to the extent to which the Fed is still on hold. But the most important driver to the region’s central bank’s policy thinking is what is happening to the dollar. In 2018, when tariffs were imposed, you had seen the dollar was rising and even while tariffs were deflationary for the region like it is right now and caused a slowdown in growth, central banks were having to hold back their rate cuts until the Fed started thinking about taking up its own rate cuts.
But in this cycle, to the extent to which the dollar has been weakening, Asian central banks have been going ahead and cutting interest rates and just by the fact that investors are outside of US thinking about hedging their exposure to the US by way of concerns on weakening dollar, that is causing further weakness in the dollar and giving some support to the capital inflow into rest of the world as well, particularly Europe and Asia.
What about the other part of the puzzle which is inflation, because you have talked about pencilling in or foreseeing disinflation in Asia’s core economies. What is your base case for interest rate cycles in India and how is that going to play out when it comes to affecting the capital flows because we are working with another 50 bps cut for the rest of the calendar year. That is the consensus on the Street and it could be as steep as another 25 bps cut on Friday.
Chetan Ahya: Yes, for India and the region, we are having a starting point of inflation which is relatively low. We are seeing a decline in oil prices, that is further causing disinflationary pressures. At the same time, we have seen tariffs going up. Tariffs are always deflationary for the countries on which tariffs are imposed and add to that weakening dollar, i.e., strengthening of Indian rupee as well as other Asian currencies. You are going to see inflation decelerate further and that allows the central banks to cut rates more meaningfully. We are expecting two more rate cuts from the RBI and we are also highlighting the risk that RBI could take up a third rate cut and take the cumulative rate cuts from here to 75 basis points if growth damage out of the global trade slowdown turns out to be more than what we are building in right now.
