Animal spirits are very much alive

India’s economy is shrugging off global trade wars, relying on domestic consumption to stay on course to becoming the fastest-growing major economy this year.

Demand for bank loans remained solid going into the July quarter despite rising interest rates, and so was the case with services and manufactured goods. Foreign investments slowed, highlighting risks to India’s balance of payments position.

Other risks loom in the form of higher oil prices, tightening global financial conditions and a shortfall in taxes that can put budget targets out of reach. For now, the economy is showing steady expansion, with the International Monetary Fund forecasting growth of 7.3% in the fiscal year through March 2019 and 7.5% in the next as reforms initiated by Prime Minister Narendra Modi pay off.

India’s main services index rose at the fastest pace in 21 months in July, the latest purchasing managers survey showed, while manufacturing continued to expand, but at a slower pace. These together pushed the composite index to its highest level since October 2016. The optimism stems from a rise in new orders, giving confidence to businesses to produce more.

On the price front though there are were mixed signs. Services providers were unable to fully pass on rising costs, while manufacturers increased output charges for the 12th straight month.

Data from the central bank also showed an uptick in capacity utilisation to above 75%. That gain usually drives inflationary pressures and indicates improved pricing power, which eventually provides more incentive to invest.

Exports grew by a relatively strong 14.3% in July from a year earlier, although slower than the 18% pace in the previous month. Economists and policy makers are optimistic that the recent weakness in the rupee will help support the recovery in sectors such as textiles.

Data from the Society of Indian Automobile Manufacturers show that the industry produced more vehicles in July than a year ago, with the increase led by commercial vehicles and two-wheelers. Total sales were up 8% in the latest indicator, underpinning a view that domestic demand is holding up well.

With more consumption comes more demand for loans. Bank credit rose 12.7% in August from a year ago, with most of the loans being made to the services sector. Commercial paper issuances are also on the rise.

But those numbers aren’t telling the whole story. The rise in bank credit over the past year largely due to favorable base effects. Rising borrowing costs have instead crimped corporate bond issuances, indicating that total credit flowing to the corporate sector is weak.

Foreign direct investments fell to their lowest since January, and that could weigh on India’s balance of payments. Already, the current account deficit is expected to widen due to higher oil prices and slowing inflows into the capital markets.

With a general election due in early 2019, concerns about policy paralysis and whether Modi will manage to repeat his 2014 landslide-win may keep many investors on the sidelines.

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