Vijay Kumar Gaba

Economy: Activity holds up; strong sequential rebound led by seasonality (Nirmal Bang)

Early data for March’23 indicate that 78.1% indicators were in the positive territory on YoY basis, up from 68.8% in Feb’23. Final data for Feb’23 indicate that 71.4% indicators were in the positive territory on YoY basis.

On a sequential basis, there was a sharp rebound in March’23, led by seasonality. Around 75% indicators were in the positive territory in March’23, up from 50% in Feb’23. Final data for Feb’23 indicate that 34.7% indicators were in the positive territory.

Urban unemployment edged up to 8.5% in March’23 from 7.9% in Feb’23. Rural unemployment rose to 7.5% in March’23 from 7.2% in Feb’23.

Rural wages have sustained their rebound since mid-FY23 and rose by 8.1% YoY in Jan’23 vs. 7.6% YoY jump in Dec’22. In other rural indicators, tractor sales continued to hold up, growing by 13.7% YoY in March’23 vs. 20% YoY growth in Feb’23 (up by 32.9% MoM). Two wheeler (2W) sales grew by 9% YoY in March’23 (up 8.8% YoY in Feb’23) and were up by 14.2% MoM.

Motor Vehicle sales grew by an estimated 12.8% YoY in March’23 and were up by 12.2% MoM. Commercial Vehicle (CV) sales grew by 12.8% YoY in March’23 (up 3.2% YoY in Feb’23) and were up by 27.8% MoM. Passenger Vehicle (PV) sales grew by 4.5% YoY in March’23 (up 11% in Feb’23) and were flat MoM.

The S&P Global Manufacturing PMI improved to 56.4 in March’23 from 55.3 in Feb’23. Manufacturing as measured by the Index of Industrial Production (IIP) grew by 5.3% YoY in Feb’23.

The S&P Global Services PMI moderated to 57.8 in March’23 from a 12-year high of 59.4 in Feb’23. Traffic indicators moderated from peak levels or were largely flat. Diesel consumption was up by 1.1% YoY in March’23 (up 7.4% YoY in Feb’23) and petrol consumption was up by 6.8% YoY in March’23 (up 8.8% YoY in Feb’23).

Banks’ credit-to-deposit ratio continued to inch up and stood at 75.8% in March’23. Bank’s non-food credit growth continued to moderate gradually and stood at 15.4% YoY in March’23 (up 15.9% YoY in Feb’23), although it was up 1.8% MoM. Deposit growth continued to remain under pressure at 9.6% YoY in March’23 but it was up 1% MoM.

Near-term outlook for economic activity remains uneven (ICRA)

External demand is expected to be cautious following the ongoing geopolitical tensions and continuing Monetary Policy tightening by major Central Banks of some advanced economies, which could weigh on merchandise and services exports.

The GoI has enhanced high-multiplier capital spending in the Union Budget for FY2024. The large pipeline of infra projects, scheduled to be completed in FY2024, will aid in pushing project commissioning and thereby support investment demand. Timely execution remains the key.

Private sector capex is likely to pick up in FY2024 amid the rise in value of new project announcements, improving capacity utilisation levels, PLI schemes and GoI initiatives pertaining to clean energy. Besides, the GoI’s capex push has the potential to ‘crowd-in’ private capex.

Consumption of services remains quite robust while demand for goods is somewhat uneven. A sustained moderation in inflation would be the key to support consumption of low- and middle-income households.

India strategy: Behind the relief rally are incipient concerns on banking (Systematix)

India’s ranking moves up amid optimistic projections, while ROW factors in a recessionary scenario: Following the relief rally post the recent global banking debacle, our global ranking for Nifty has moved up from 13 to 6 since the end Feb’23 on the back of only a modest downgrade F1 EPS by 0.5% compared to the pervasive cuts in expected earnings and ROEs for major global benchmark indices reflecting the deepening worries about a global recession. Notably, European benchmarks, China, and the US have seen sharper declines. India’s upgrade is despite rich valuations- Nifty (49% higher than the global average F1 PE of 14.4x) and Sensex (57% higher). India’s growth optimism embodies a decoupling thesis of sorts, which is unsustainable.

India earnings outlook: Further earnings downgrade potential remains: We expect further downside surprises to earnings due to a) lower than expected margins (as also demonstrated by initial 4Q results), b) deceleration in bank credit growth, c) slowing urban demand, and d) weak real GDP growth (4.4% in 3QFY23) amid global spillovers. Rural demand is on a moderate revival path. Hence, the forward consensus projection for NIFTY EPS growth of 14.3% CAGR (FY22-FY25E) is significantly optimistic; we continue to expect downgrades.

Episodic bounties for Indian banks dissipating now: Extending our earlier UW view on banks and BFSI sectors in general, our latest analysis and evidence fortify prospects of deceleration in lending growth and re-emergence of NPA cycle. Sectoral allocation of bank lending for Feb’23 reinforces the evidence that there is a broad-based deceleration in industrial lending even as lending to retail and NBFC remains robust. We believe with a lag the latter will also see a moderation. The slowdown in mortgage lending could be a precursor. In a scenario of credit growth decelerating to 10% from the current 15% and retail inflation falling from 6.7% to 5%, the GNPA ratio could rise by 200bps!!

Rising probability of rural wage-price; OW on consumption remains: The structural rise in dependence on the Agri sector, trend rise in cereal consumption, and the weather anomalies point towards the sustenance of rising wage-price spiral and higher terms of trade for the Agri sector. The expected drags on non-agri rural from lower remittances from urban areas and cutback in rural allocation in the Union Budget are juxtaposed against the imperative of the upcoming state and general elections. These will eventually force populism favoring the rural sector, Hence, our OW views on staples and agri sector remain supported.

Steel industry faces cost-competitiveness test as EU implements CBAM (CRISIL)

The cost of India’s steel exports to the European Union (EU) could rise as much as 17% following full implementation of the Carbon Border Adjustment Tax Mechanism (CBAM), which mandates stringent disclosures and purchase of carbon credits to offset the impact of emissions. Accounting for greenflation, which will drive overall steel prices higher, the total impact could be as high as 40%.

Under the mechanism, which the Council of the EU and European Parliament have agreed to implement from October 1, 2023, importing EU nations will seek quarterly disclosures across seven emission-intensive sectors from April 2024, and to gradually penalise emission differentials between 2026 to 2034 through purchase of carbon credits to bridge the cost differential with steel produced in the EU.

The seven sectors – iron and steel, aluminium, cement, fertilisers, electricity, as well as chemicals and polymers — account for ~35% of India’s exports to the EU in the merchandise space.

The EU move is a part of a long series of global emission-reduction measures implemented in recent years — such as COP26, under which India committed to Net Zero by 2070, and COP27, under which the milestone targets have been made more aggressive.

To be sure, the “common but differentiated responsibilities” formalised under United Nations Framework Convention on Climate Change have placed enhanced flexibilities on developing economies, providing them an opportunity to choose differentiated timelines for meeting Net Zero goals.

However, regulations such as CBAM, through which the EU wants to prevent an increase in outsourcing of product manufacturing to countries where implementation linked to carbon emission reduction is slower than in the EU — plugging carbon leakage as it were — may go a step beyond and force specific industries to expediate implementation or face heightened risk for business loss or cost-competitiveness.

Under CBAM, exporters will need to make quarterly reporting of emissions starting October 1, 2023, and from December 31, 2025, buy Emissions Trading System (ETS) certificates for their greenhouse gas emissions.

In the absence of a carbon-neutral technology, industries have been allocated free allowance starting at 100% in 2025 and ending at 0% by 2034. The ETS tax would be gradually applicable to the portion that does not enjoy the allowance.

Dollar’s rate advantage is narrowing (ING Bank)

The week has started with the market leaning again in favour of European currencies and the dollar losing some ground. The price action in short-dated bonds showed a reinforcement of European hawkish bets while the whole US Treasury yield curve inched lower.

While a 25bp hike next week by the Fed does not look under discussion, Fed rate expectations have remained rather un-anchored and volatile when it comes to future policy moves. This continues to leave ample room for speculation about Fed Chair Jerome Powell’s tone in terms of future guidance. While data will clearly play a role, recent developments in the US banking sphere are creeping back onto investors' radars. First Republic Bank reported a larger-than-expected drop in deposits in its quarterly results, sparking a new round of heavy selling in the stock after a prolonged period of calm.

Should there be fresh instability in US banking stocks, dovish Fed bets may gather more momentum, and despite its safe-haven status, the dollar could stay on the back foot to the benefit of European currencies backed by hawkish central banks and without an excessively high-beta to sentiment.

Engineering and Capital Goods (Nuvama)

India’s capex landscape has been growing energetically since FY19, evident in governmentspending data and nominal GDP growth (Exhibit 1). This begs the question– where is the money being spent? Our study of India’s capex data notes a definite uptick in ordering across ‘three key legs’ of capex growth – Railways, Renewables and Power T&D coupled with conventional industrial/infra capex. We also observe a strong degree of conviction in opportunities in new age frontiers such as EV ecosystem, data centres and defence. This brings to the surface multi-year growth opportunities in transmission and railways – each potentially bagging meaty orders (INR120–150bn annually for HVDC transmission; INR250–350bn annually for locos plus trainsets product value for railways).

Transmission: The power demand-supply dynamic in India (link) clearly spells out that, if India is to avoid a power deficit by FY28–30, its plan of adding 30–40GW/year of renewable energy (RE) comes to stand as more of ‘a need’ than ‘a choice’. The natural deduction is that this will need to be connected, and to connect RE at this scale an equally large transmission capex is imperative (INR2.4tn as per CEA estimates; Exhibit 6). Given the backdrop, we estimate PGCIL’s capex (a barometer for India’s transmission capex) will likely double over the next two–three years. Hence, a fresh capex cycle in power transmission has already begun after a gap of ~4–5 years. Capex is expected across high voltage (rising CAGR) and medium/low voltage range (bulk of volumes), at the ISTS level. CEA estimates INR2.4tn to be spent in this area over FY24–30. India plans to add transmission lines/substations in the 400–800KV range, along with four large HVDC projects (worth approx. INR1tn).

Railways/new age capex: The mega push in rail capex will benefit the entire industrials value chain over this decade. Cyclically strong industrial capex (conventional segment) along with new-age areas such as EV ecosystem, data centres, RRTS/metros, wastewater management, warehouse and logistics, defence, smart infra etc. will continue to drive order inflows especially in low/medium voltage T&D products and relevant equipment suppliers through the next decade.

The growth story continues with > 1,100 loco orders expected annually for the next 2–3 years (vs. 700 till FY21). Of ~1,000 VB train sets, ~302 have been ordered and 600–700 more VB train orders are expected in future. Siemens is present across locos and trainsets (partner required) and we factor at least one more large loco/train set order by FY25E (INR100bn).

Industrial equities across our coverage universe have significantly re-rated over the past ~12–24 months, led by high industrial capex/infra momentum, which is evident in order inflows growth (across sector) and margin expansion (not yet broad-based). Most MNC equities  are currently trading above their long-term medians.

FMCG - Macro situation yet to recover (IIFL Securities)

For FMCG to grow well, good income growth in the low-income consumers is required. These consumers have two main sources of income viz Farm income and wages. Previously, when Farm income and wage growth is robust, FMCG companies tend to post strong sales growth and vice versa.

Past 20 years can be divided into 3 periods: FY00-06 when sales growth was weak, FY07-14 when it was strong and FY15-20 when it was weak again. The strong/weak periods of FMCG growth coincided with strong/weak periods of Farm inflation and Wage inflation.

Wage growth improving: While writing our CY23 outlook, the real rural wage growth (for Sep ’22) was -2.7%. It has now improved to -0.5% (for Jan ’23), but is still not healthy enough to boost growth. Moreover, Non-agri real wage growth is even poorer at -1.4%, denoting slow pickup in economic activity outside of agriculture. The improvement over past few months is led by both nominal wage growth improving and inflation moderating. While currently still lacklustre, the trend if continued will be positive for FMCG players. We need real wage growth at ~2% or higher to sustain good volume growth.

Farm inflation moderating: While real wage growth has shown some small improvement, our proprietary IIFL Farm index has been lacklustre since past few months, and is showing a 3% YoY inflation in Feb’23. Vegetable prices, down ~20% is the main reason, despite cereals and milk prices witnessing double-digit inflation. Moreover, assuming that prices remain stable at current levels, YoY inflation will trend lower than the current 3% for each of the next 12 months.

We need further sequential inflation to pick up for the YoY growth to continue meaningfully. Over the past 3-5 months, the index has been largely flat. For FMCG growth to be strong, we need Farm inflation equal to or higher than CPI.

How to play the sector: Visibility of a good growth is better for Food companies in near term. Investors with short-term horizon can invest in Food companies, whereas HPC investors may require a slightly longer horizon. We recommend that investors start off with large companies currently in absence of visibility on the time and extent of recovery, and then shift into smaller companies in inverse proportion to the strength of the expected recovery as and when macro indicators suggest it. This is because large companies are better suited to weather the storm on account of their strong brands, better management talent, systems and processes. Smaller players tend to have a leverage to recovery as consumers as well as wholesalers increase the repertoire of categories and brands when demand conditions are robust.

Microfinance Industry Beats Covid Blues, Likely to Grow by 25% in FY24 (CARE Ratings)

The Microfinance industry (MFI) experienced a growth spurt in 9M FY23, expanding at a rate of 12% Y-o-Y due to a favourable macroeconomic climate and renewed demand from tier-III cities, which has led to a surge in disbursements over the past few months. NBFC-MFIs have surpassed banks in the overall microfinancing landscape, constituting approximately 38% of the total outstanding microfinance loans as of December 31, 2022, compared to 36% for banks.

CareEdge Ratings anticipates growth momentum to continue, with the NBFC-MFI portfolio growing at a rate of 20%-25% over the next 12-18 months. However, an increase in interest rates, high inflation, or another wave of Covid-19 could potentially impede economic growth and, as a result, impact the Microfinance sector adversely.

The removal of the lending rate cap by the Reserve Bank of India (RBI) has enabled MFIs to engage in risk-based pricing, which has boosted net interest margins (NIMs) and, in turn, increased returns on total assets (RoTA).

Credit costs have declined from their peak in fiscal year 2021 but still remain higher than pre-Covid levels, with a portion of the restructured book slipping into NPA. We expect NIMs to continue improving, resulting in RoTA rising to approximately 3.25% for fiscal year 2024, aided by controlled credit costs of approximately 2.5% for the same year.

Asset quality, although on an improving trend, still remains moderate as compared to the pre-Covid level owing to additional slippages arising from the restructured portfolio. The MFI sector has taken the cumulative impact on the credit cost of around 13% of average assets from FY21 to H1FY23 due to Covid-19. However, with an improving collection efficiency trend, GNPA is expected to improve to 3.5% and 3% in FY23 and FY24 respectively from a peak of 6.26% for FY22.

In terms of capital structure, NBFC-MFIs have managed to raise ₹3,010 crore of equity in 9MFY23, compared to ₹1,506 crore and ₹1,431 crore in FY2021 and FY2022, respectively, indicating a renewed interest from investors.

Nevertheless, due to the current global turbulence, investors are likely to exercise greater caution and selectivity in the future. Additionally, with increased support from investors and rising disbursement levels, the gearing level was 3.7x and 3.6x as of March 31, 2022, and December 31, 2022, respectively. We anticipate that the gearing level for the MFI sector will moderately increase to around 3.9x by March 31, 2024.

NBFC-MFIs Outpace Banks

The microfinance industry has experienced a shift in market share, with NBFC-MFIs overtaking banks for the first time in four years. While banks held a dominant position during the Covid-19 period, the growth rate of NBFC-MFIs has now surpassed that of banks, resulting in NBFC-MFIs commanding a higher market share in the overall microfinance sector. As of 31st December 2022, NBFC-MFIs contributed around 38% to the outstanding overall microfinance loans, compared to banks' 36%. With a growth rate of around 20% till 9MFY23, NBFC-MFIs are currently leading the industry.