India will rejoin the ranks of the fastest growing major economies in the world next fiscal year, even as a massive cash crunch is expected to drag growth lower in the current year.
India's economy is forecast to grow 7.5 percent in the financial year through March 2018, according to Deutsche Bank. Goldman Sachs pegged the number higher at 8.6 percent.
In the short-term, experts predict a sizable dent to growth in the final two quarters of fiscal 2017, led by a sharp drop in consumption as a result of the government's attempts to crack down on undeclared income and counterfeit notes. Deutsche Bank expects India's overall growth to slow to 6.5 percent on-year in the current fiscal year.
By contrast, Deutsche Bank expects the Philippines, another major Asian economy, to grow 6.8 percent in 2016. An exact comparison between the two countries, however, is somewhat complicated since the Philippines uses a calendar year to report economic data, while India calculates its fiscal year from April to March.
India demonetized 86 percent of total value of currency in circulation in a country that is heavily reliant on cash, bringing daily life to a halt.
Prime Minister Narendra Modi anticipates some relief early next year. On Monday, Reuters reported activity in India's services sector contracted last month, with the Nikkei/Markit Services Purchasing Managers' Index sinking to 46.7 from 54.5 in October. A reading below 50 indicates contraction.
"We see this as a one-off," Taimur Baig, chief Asia economist at Deutsche Bank told CNBC. "There won't be a major permanent loss of activity or wealth (and it will) rebound by the time the dust settles in March, April of next year."
The recovery will be supported by growing agricultural demand due to a better-than-expected monsoon season in fiscal 2017, higher wages for public servants due to a wage bill passed in June 2016 and increased public spending, Baig said.
Deutsche Bank's forecasts show private consumption is expected to grow by 8.1 percent on-year in the 2018 fiscal year. In fiscal 2017, private consumption is predicted to grow only 5.9 percent on-year.
Private sector investments to remain subdued
Capital expenditure in India's private sector has been lackluster as companies and public sector banks have struggled with bad debts and non-performing assets.
"The bad debt problem in the corporate sector is still substantial," said Baig. He added that banks have to recapitalize themselves and clean up their balance sheets before they become a far more "enthusiastic participant in domestic fixed asset formation," a scenario not likely to play out over the next four-to-six quarters.
In the 2016-17 budget, India's government allocated 250 billion rupees ($3.67 billion) toward the recapitalization of public sector banks. Baig, however, reckoned the pace at which the government was pursuing banking sector restructuring was "fairly slow."
An interest in Indian bonds
Indian companies have historically relied on bank loans to raise resources. With the availability of loans scarce in the next several quarters, experts believe companies could turn to the bond market for capital raising.
"We've seen a very sharp decline in bond yields so non-bank financing might be the first area where we see some encouraging developments," said Baig.
Since bond prices move inversely to yields, a lower yield suggests a higher demand for bonds among investors.
Uptick in inflation and headwind from oil
Inflation, which is expected to dip in the current fiscal year as consumption drops, is predicted to rebound in fiscal 2018. Goldman Sachs expects core inflation to rise gradually to 5.3 percent on-year from 4.7 percent in fiscal 2017.
The investment bank reckoned prices will be driven by disbursement of housing rent allowances to central government employees as well as climbing energy prices.
Oil prices have remained steady above the $50 a barrel mark since last week, when OPEC announced plans to reduce production by 1.2 million barrels a day by January 2017.
Experts see higher oil prices as a headwind for India since it is a net importer and has, in recent years, benefited notably from the slump in commodity prices.
Baig, however, disagreed and said even as an importer, India's oil refining sectors would receive some boost from the rise in oil prices. Deutsche Bank expected India's trade account deficit to only rise gradually over the next few years.