India: Record GDP plunge among worst globally

On 31 August, India’s National Statistical Office (NSO) released GDP data for the second quarter. The print came in at -23.9% y/y, which is worse than our forecast (-19.8%) and consensus (-18.1%). As India’s lockdown was one of the most stringent across the globe, it is not surprising that the economic contraction in Q2 is also one of the worst globally. Both investment and private consumption plunged, contributing -15ppts to the economic contraction. The positive contribution of net exports is caused by a severe drop in imports, which fell by a staggering 40% y/y. Going forward, we expect the Indian economy to experience another quarter of contraction (of -0.7%), before pushing into positive territory again (see table 1).

Meanwhile, the Indian rupee has been appreciating on the back of global risk-on sentiment and a significant weakening of the USD (figure 2). Especially portfolio investment in Indian equities have been remarkably positive since May. With limited intervention by the RBI, USD/INR currently stands at 73.3. Although we also have been forecasting an appreciation of the INR, the latest rally was stronger than expected. Going forward, we expect the INR to push towards 72.7 up to November, but this trajectory is expected be disrupted by increasing geopolitical tensions before the year is over (figure 2).

Against the backdrop of a heavily affected economy and limited policy room to manoeuvre, the Indian government is especially aiming to improve economic prospects for the medium term. One important aspect of this strategy is the aim to limit dependency on China with respect to trade and technology and foster local economic activity. Imports from China have tripled since 2005 and currently amount to 15% of total imports, mainly consisting of telephones & computers.

The military clash on the India-China border has sped up plans to disentangle economic ties with China and policy action has already been taken. For instance, the Indian government aims to phase out Huawei from its telecommunication network, but will likely refrain from imposing a formal ban. Moreover, the FDI policy has been amended in order to protect local companies from hostile takeovers by Chinese firms. On the technological front India is also firming its stance towards China, e.g. by banning 118 Chinese apps (including TikTok, WeChat, Alipay). Finally, Japan, Australia and India announced that they will be working together on a Supply Chain Resilience initiative to decrease dependence on China. This all signals that India is actively pursuing collaboration with other countries to decrease dependency on China.

Besides attempts to disentangle the economy from China, the government also tries to put India in pole position as an investment destination for manufacturing and IT activities. This ambition is not new and has been spurred by the national program: Make in India. However, realization of this ambition has been held back by complicated laws, regulations and red tape. This is reflected in the Ease of Doing Business ranking of the World Bank, which made India a relative less attractive manufacturing destination compared to other Asian emerging economies.

In recent years, however, India has made improvement in its business environment (figure 3), moving up from place 134 on the Ease of Doing Business index to place 63, in only 5 years. Last year, India even overtook the Philippines and Vietnam. Moreover, India is trying to strike the iron while hot, as companies are increasingly moving supply chains away from China. Covid-19 painfully exposed the vulnerability of firms depending solely on China as the main manufacturing hub. Hence many governments are actively stimulating companies diversify and adopt a so-called China + 1 strategy.

Attempts by the Indian government to attract foreign investment indeed seem to be bearing fruit. According to India’s government think-tank Niti Aayog, India received USD 22bn of foreign investment during the heights of the COVID-19 crisis. Many large companies have signalled that they are planning to expand activity in India. Mid-July Google announced that it will be investing USD 10bn in India in the coming years after having “extremely fruitful” discussions with Prime Minister Narendra Modi. Last year, we already argued that India tops the list of emerging markets which might benefit from businesses exiting China, but the macro data has not been supporting this claim. Based on recent developments, we think it is just a matter of time before it does.