Indian economic growth likely to pick up pace in 2017-2018, inflation to remain within target rate through 2018

The Indian government’s demonetization attempts have led to the economy facing temporary headwinds. Prime Minister Narendra Modi announced in early November that the Reserve Bank of India would withdraw existing 500 and 1000 rupee notes from circulation by the end of 2016. This process led to a shortage of cash for Indian consumers because of the central bank’s insufficient ability to print replacement notes.

As India is primarily a cash economy, the demonetization drive had a negative effect on consumer and business spending. A higher deposit base in the banking system is expected to underpin the economic growth in medium term. This might translate to lower interest rates and higher lending, noted Scotiabank in a research report. Domestic demand is likely to continue to be the main growth driver, but the economy would struggle with a lack of private-sector investment until India’s business environment rebounds further.

“We estimate that real GDP grew by 6.8 percent in 2016. The pace will likely pick up to 7½ percent y/y in 2017-18, keeping India among the world’s growth outperformers”, stated Scotiabank.

Meanwhile, the inflation environment of India is favorable. The headline rate came in at 3.4 percent year-on-year for the whole of 2016. But price gains are likely to have bottomed in January and would rebound gradually in the months ahead. However, inflation is anticipated to stay curbed, remaining within the Reserve Bank of India’s target of 4 percent, plus or minus 2 percent year-on-year through 2018, added Scotiabank.

The central bank is likely to lower its policy rate by 25 basis points to 6 percent later today in order to keep a balance between strengthening economic growth impacted by the demonetisation move and making sure the retail inflation target of 4 percent ± 2 percent to be secured on a durable basis.

The chance to inject additional monetary stimulus into the Indian economy is expected to close following the February policy meeting and further rate reductions are unlikely in the near future, according to Scotiabank.