THE JUGGERNAUT IS ROLLING
--As we enter into the 11th month of the new government, the initial feeling of Euphoria is giving way to some despondency and a feeling that nothing much has changed and there is no move forward. While it is true that there are elements of policy as well as implementation that could have moved faster the fact is also that a lot has been done and the impact of the same will be seen on the ground over the next 3-6 months.
An economy is like a huge boulder, when it is moving in momentum it moves smoothly and without friction. However when it has been bought to a standstill, like what happened during the UPA regime then it is difficult to move it initially, however after an initial impetus has been provided then gaining further speed is relatively easier. I do believe that the government has moved on several directions and the impact of the same will be seen in terms of growth going forward.
Reasons for a slow pickup initially are as follows
Consumer growth is subdued- Consumer demand has continued to be subdued despite inflation coming off and there being a feel good factor. The reason for this is simple. We had a period of nearly 5 years when Consumer Inflation was more than 10%. This was also a period when economic growth was slowing down. In such a situation most people used their surpluses to consume. Consumer demand continued to be strong even when inflation and interest rates were high in the initial period and cooled off subsequently. Similarly even when inflation has come down and there is a huge stimulus due to lower crude oil prices the pickup in consumption demand will take time as people need to be more confident of the sustainability of the move. Salary growth has lagged inflation over the last few years and this is now having a delayed impact. Rural demand has also been hit due to poor weather and low agricultural commodity prices.
Investment demand pickup is low- Most companies today have excess capacity driven by a long period of below par growth. The only thing that can contribute towards a pick up in investment demand is the infrastructure sector. Given the issues around the Land Bill as well as various issues plaguing stuck infrastructure projects is has taken time to get things off the ground. However now we see activity in several sectors especially roads. A lot of projects stuck due to regulatory issues have also got cleared. As the investment cycle starts we will see capacity utilizations across the board go up and the virtuous cycle will eventually lead to corporate capital expenditure pick up. We could have seen some faster movement in this segment, however nevertheless there is decent traction now and the impact should be seen in the second half of the year.
Banks are wary of lending and interest rates have been slow to come down- Inflation and inflationary pressures have come down substantially over the last one year. Some of it has been due to the crash in global commodity prices and the rest due to subdued demand in the economy as well as a high base of agricultural commodity prices in the previous year. Despite ample liquidity and RBI rate cuts banks have been slow to pass on interest rate cuts mainly driven by the poor state of their balance sheets. Private Sector banks have benefited due to the poor asset quality of PSU Banks and have been able to expand their Net Interest Margins. However the passthrough is happening now. Contrary to fears about a potential spike up in Consumer inflation due to unseasonal rains it is unlikely to happen as extended cool weather as well as soil moisture will lead to higher summer vegetable production. Monsoons are the joker in the pack and we need to see which way they go. However lending rates are likely to maintain a downward trajectory for the foreseeable future. The worst of bank asset quality will also be seen in the current results season. This will set the tone for better transmission and an impetus to growth going forward.
Overvalued rupee has hit exports- An overvalued INR driven by optimism around India’s growth revival as well as an improved Current Account Deficit has hit exports big time. High interest rates relative to global rates combined with the overvalued rupee has made Indian Exports uncompetitive. This has hit the growth in the external sector.
The way forward
In my view a combination of the steps that the government has taken legislatively combined with the impetus on boosting investments will start showing in growth numbers in the second half of this year. As inflation remains low and interest rates trend down we will see that translating into greater consumer as well as investment demand. Exports on the other hand will continue to be an area of concern.
The progress of the Land Acquisition Bill will be interesting to watch. I see it similar to Manmohan Singh’s conviction on the India-US Nuclear deal for which he staked a lot. PM Modi seems to be taking a similar stance on the Land Bill. A success here will be very positive. The other key bill is the GST Bill which could actually pass through much more peacefully.
The Bureaucracy is still slow to move as the amendments to the draconian provisions of the Prevention of Corruption Act are still be passed by parliament. This has been in limbo for several years now. Most people underestimate the impact of this on decision making given that several bureaucrats have been pulled up and charged despite no personal benefits over the last few years.
Taking into account the lead factor of 12-18 months I see a strong revival in the economy panning out just a few months from now. This will translate into higher earnings growth for corporate India and give a boost to stock market performance. The markets have remained in a range for the last 6-7 months and are now more or less at the same levels at which they were in September 2014. That was also the time I had become somewhat wary about the way the markets were getting delinked to the economy. The current corrective move should provide a good opportunity to get into the markets to ride a better second half.
The Elephant has started moving, there is acceleration ahead.
Sandip Sabharwal is a Fund Manager & Investment Advisor.