India’s $4 trillion economy is undergoing a structural slowdown, according to the investment-bank research team of a leading Swiss financial institution UBS. Unlike cyclical factors such as oil-price fluctuations or reduced government spending, this slowdown is driven by deeper, long-term challenges like weakening credit growth, declining foreign investment, waning export competitiveness, and subdued earnings growth.
The deceleration is expected to worsen under the backdrop of a higher-interest-rate environment in the US. “India’s perceived insulation from US economic risks is questionable,” said a senior emerging markets strategist at UBS. The country faces challenges due to its high debt service-to-revenue ratio, which could pressure its growth trajectory as US Treasury yields remain elevated.
Markets in Decline
Indian financial markets have taken a hit, with equities losing nearly $500 billion in market capitalization over the past month. The MSCI India Index is off to its worst yearly start since 2016. The rupee has plunged to all-time lows, becoming Asia’s weakest-performing currency. Meanwhile, foreign investors have been withdrawing from Indian bonds at a pace not seen since 2020, dampening enthusiasm about their inclusion in global bond indices.
These market losses coincide with a noticeable decline in India’s real GDP growth, which has fallen below the pre-pandemic average of 7%. Disappointing corporate earnings, particularly from companies in the Sensex index, have amplified the bearish sentiment. Analysts highlight that even traditionally resilient sectors like consumer staples are beginning to show signs of strain, suggesting that the downturn extends beyond temporary factors like government spending.
Key Long-Term Challenges
1. Slowing Credit Growth: The Indian banking system is facing tighter credit conditions. Loan-to-deposit ratios have hit a record high of 80%, forcing banks to rely on deposit growth to sustain lending. This will likely bring credit growth down to 10% annually, compared to the 16% average over the past two years.
2. China’s Competitive Edge: India’s industries are grappling with cheaper imports and stiffer competition in global markets due to a weaker Chinese yuan and falling export prices from China. The rupee, despite recent declines, remains significantly overvalued compared to historical averages, further straining India’s export competitiveness.
3. Declining FDI Inflows: Foreign direct investment in India has slowed significantly, with only $3 billion recorded over the past year. This decline reflects growing investor concerns about the economy’s underlying growth potential.
4. Market Saturation: Indian households now hold 23% of their financial assets in equities, with equity holdings making up 60% of bank deposits. This marks a shift from the earlier narrative of an “underpenetrated” market, suggesting limited room for fresh investment inflows.
5. Valuation Concerns: India’s market valuations are trading at an unprecedented 72% premium compared to other emerging markets. Such high valuations could deter investors looking for better returns elsewhere.
Policy Dilemmas for the Central Bank
The Reserve Bank of India (RBI) faces a tough policy conundrum. Cutting interest rates to stimulate growth may weaken the rupee further, potentially triggering capital outflows at a time when foreign equity and FDI inflows are already under pressure. On the other hand, maintaining high rates could stifle economic recovery.
UBS suggests a cautious investment approach, recommending bearish rupee options to hedge against an expected 2.6% currency depreciation this year. However, the bank also advises taking positions in rate-receiver swaps, anticipating a 75 basis-point rate cut in the near future.
Conclusion
As India navigates these structural challenges, investors and policymakers must prepare for a slower growth trajectory in the coming years. With external risks, high valuations, and declining investment inflows weighing on the economy, achieving sustainable growth will require significant policy reforms and structural adjustments.
