Vijay Kumar Gaba

India’s real GDP is expected to grow ~7.8% in the current year FY24. At this rate, India’s growth would be the fastest among all major world economies. Indubitably, it is a matter of comfort for all Indians. Investors are celebrating as markets are buoyant and asset prices are rising.

The Indian economy has grown 9.7% (yoy) in 1HFY23, as compared to 13.7% growth recorded in 1HFY22. Given the consensus growth forecast for FY23 is around 7%, the implied growth rate for 2HFY23 is close to 4% (yoy).

Further the forecast for FY24 are veering around 6.2% (ranging from 6% to 6.4%), given the rising global slowdown hitting exports further; lagged impact of monetary tightening likely hitting in 1HFY24; investments slowing down on poor demand growth visibility and persisting high inflation further hitting domestic savings.

It is therefore likely that the Indian economy might grow less than 5% for the next four quarters. This will be the period that may see a very high decibel drama in the global theatre. The current trends indicate that the monetary tightening by the US Fed and other global central bankers has already started to impact the demand and employment. The consumer demand, housing starts, and high paying jobs are showing a distinct downward trend. Similar trends are also visible across Europe. Easing bond yields, despite likelihood of further hikes and tightening by the central bankers, at least till 1Q2023, is clearly indicating a notable slowdown in the global economy in 2023.

The long term growth trend (5yr CAGR) continues to remain below par.

2QFY23 GDP data had some trends that should worry markets. For example—

• Industry sector growth contracted by 0.8%, mainly led by decline in manufacturing activity (-4.3%).
• Government consumption contracted 4.4%, while private consumption was also lower YoY as well as sequentially.
• Exports continued to slow for the seventh consecutive quarter. 2QFY23 export growth of 11.5% was the lowest post pandemic. Net export is likely to come under further stress given the looming global slowdown, which would likely dent global demand further.
• Services growth (9.3%) was also lower YoY (Q2FY22-10.2%) and sequentially (1QFY23-17.6%), mainly dragged by community and defence services.
• Subsidy disbursement was poor, while tax collections were strong, resulting in lower GVA growth of 5.6%.
• The Gross Domestic Savings (GDS) at 26.2% of GDP in 1HFY23 is the lowest in two decades.
• The April-October 2022 fiscal deficit is reported at 45.6% of FY23BE. This materially higher as compared to 36.3% in the similar period of FY22. This number read with higher tax collection, lower government consumption, lower subsidy distribution and sharp rise in government investment implies that 2HFY23 could see slower government capex.

Besides the economic data, the market fundamentals are also indicating headwinds for markets in the next few months. For example—

• The present spread between 10yr US Treasury yields and 10yr GOI Treasury Yield is ~3.4%, which is lowest since the global financial crisis (2009). Given the negative BoP forecast for FY23, the USDINR may continue to be under pressure, further narrowing theoretical arbitrage for foreign USD investors. The foreign portfolio flows could be impacted if this spread sustains or narrows further.
• NSE500 EBITDA Margins at 15.7% during 2QFY23 were the lowest in ten quarters. Thus despite 29% yoy growth in sales, NSE500 PAT declined ~3%.
• Net FPI selling in YTDFY23 has declined to ~US$3bn; but the domestic flows are showing some signs of tiring. With domestic savings declining and household finances under pressure, the domestic flows may likely be moderate in the next few months at least.
• Nifty is trading at ~10% premium to its long term average one year forward PE multiple. Since, the current estimates of EPS are elevated and likely to be downgraded further, this premium could actually be higher.

I shall continue to remain cautious and not get swayed by the recent up move in the markets. I believe that the market shall provide much better entry points in the next few months. Insofar as my current portfolio is concerned, I am maintaining my standard asset allocation for now (see here). However, I would like to raise some tactical cash if the markets rally further from the current levels.

 The former NITI Aayog Vice Chairman, Arvind Panagariya claimed that India may record a real GDP growth rate of 8% in FY23. However, there are not many who would agree with him. The Reserve Bank of India has projected a growth rate of 7% for FY23, in their latest forecast. Most professional forecasters have much lower forecast for the growth in the next few quarters. The average of professional forecasters’ projected growth of the Indian economy for 2023, as per Bloomberg, is close to 6%. In their latest forecast, Goldman Sachs Group projected the Indian economy to grow at 6.9% in calendar year 2022 and 5.9% in 2023. Morgan Stanley Research expects the Indian economy to grow at 6.8% in 2022 and 6.2%in 2023. Fidelity International expects the Indian economy to grow between 5.5 to 7% in 2023.

Recent economic data has been giving mixed signals about the economy. While the domestic sector is showing resilience, the external sector continues to remain a concern.

Weak external sector

The external sector has been weak for a few quarters now. The trade deficit in October 2022 widened to a worrisome US$26.91bn. Exports dropped ~17% in October 2022 on slower global demand; while imports were still higher by ~6%.

Notwithstanding the efforts of the government to improve trade account by import substitution and export promotion; the exports have grown at a slow 4.3% CAGR in the past three years; whereas the imports have registered 14.3% CAGR in the same period, resulting in larger trade deficit. The external situation thus remains tenuous.

…offset by resilient domestic sector

In the domestic sector however there are some signs of stability. GST collections have been strong; credit growth has started to pick-up; manufacturing and services PMIs are indicating expansion and inflation is showing signs of peaking.

As per the Nirmal Bang Institutional Research, “incremental flow of credit to the commercial sector in 1HFY23 is at a multi-year high when compared to the recent past.” A recent report by the brokerage highlights that Incremental credit flow from banks, while being led by retail credit, is now becoming more broad-based, with services (mainly NBFCs), industry (particularly MSMEs) and agriculture also contributing.

As per the rating agency CARE Ratings, the quality of debt being raised and outstanding in India has been improving consistently. The proprietary CareEdge Debt Quality index (CDQI) of CARE ratings is now at almost 7 year high. As per the latest release, CDQI inched up further to 92.74 in October 2022 as compared to a level of 92.70 in September 2022 on account of increase in higher rated debt and upgrades in the investment grade rating categories.

The commentary of most corporate management indicates that rural demand is a matter of concern for now. A good rabi crop could address some of this concern; but overall the growth prospects remain modest. The Indian economy certainly does not face any prospect of recession or even a sharp slowdown; but we may not see any meaningful acceleration also in the next couple of years. The external shocks may create large volatility in the markets and provide good entry points for the money waiting on the sidelines; otherwise we are in a boring market for the next many months.

 India’s GDP grew 8.4% yoy in 2QFY22, ahead of most estimates. RBI had expected the GDP to grow 7.9% last quarter. This better than estimated growth is some relief at times when worries about worsening of Covid-19 conditions.

The growth was largely driven by Agriculture (4.5%), services including construction (9.9%) and exports (19.6%). Manufacturing growth (5.5% yoy) was below estimates, dragging down the overall industry sector growth to 6.7% yoy. While all segment of services grew at a decent pace, public services and defence were the largest contributors, growing 17.4% yoy.

Business sentiments are at multiyear high, but consumer sentiment is not improving. The household outlook on income is still below pre covid level.

The government has done a good job in managing the fiscal conditions. Subject to the government completing the promised disinvestment, the FY22 fiscal picture may be much better than the budget estimates.

The Covid management is performing very well, with the number of infected people falling to 18month low level. The vaccination program is also progressing well. The new Covid variant has certainly created some uncertainty, but as of now it does not appear that we shall see prolonged and/or extensive mobility restrictions in domestic area.

Pandemic wasted two years of growth

Statistically speaking, FY22 GDP may end up close to FY20 level, registering almost no growth for two years. In fact, 1HFY22 real GDP is about 4.5% (Rs3.17trn) less than 1HFY20 GDP. The nominal GDP of 1HFY22 is just about 7.3% higher than 1HFY20 nominal GDP.

More notably, the contribution of manufacturing; construction; trade, hotel, transport, communication; financial services, real estate & professional services etc., in 1HFY22 is lower than 1HFY20.

The latest macro data, e.g., GST collections, PMI, mobility indicators, labour participation rate, etc. indicates that the momentum has continued in 3QFY22 also. If the concerns about Covid-19 subside in next few weeks, Indian economy may record over 9% yoy growth for full year FY22; and we may achieve the FY20 level of GDP, even though the recovery may continue to be skewed and driven by government expenditure and external trade.

Consumption continue to lag behind

Both private consumption (PFCE) and government consumption (GFCE) spending are still much below the FY20 level.

1HFY22 PFCE at Rs37.32trn is about 7.7% lower as compared to 1HFY20 PFCE of Rs40.44trn. Similarly, 1HFY22 GFCE at Rs7.83trn is about 5.3% lower as compared to 1HFY20.

Even in nominal terms, PCFE has grown just 2% in 1HFY22 as compared to 1HFY20. The nominal government consumption has however grown ~9% over this period.

Investment too below FY20 level

The amount of real investments (Gross Fixed Capital Formation or GFCF) in the economy during 1HFY22 was about 8.2% lower than 1HFY20 level. Even in nominal terms, the GFCF was merely 1.5% higher in 1HFY22 as compared to 1HFY20.

5yr of 8-9% plus growth will take us to long term pre Covid growth trajectory

Pre Covid, India’s long term growth trajectory (5yr rolling CAGR of GDP) was close to 7%, which is closer to the estimated potential growth level of 7.5-8%. The trend was declining since FY18, indicating impairment of potential growth.

Indian economy would need to grow at 8-9% CAGR for next 5years to achieve the pre covid long term growth trajectory of ~7%. To achieve the potential growth rate of 7.5%-8, much higher growth would be needed on sustainable basis.

This would need much more than the higher government support to farmers and manufacturing. Structural reforms that increase the employment opportunities, improve energy security, stabilizes food prices, make tax structure progressive, and improve social and physical infrastructure sustainably must be accelerated.

Headwinds developing for 4QFY22

Though the latest macro data is encouraging, some dark clouds have gathered at the horizon, obfuscating the visibility of growth in 2022.

·  The inclement weather in the ongoing Rabi season, and fertilizer shortages have likely impacted the agriculture sector.

·  Though the overall consumption growth has been lagging; the rural consumption has remained resilient in past one year. The latest data indicates that the resilience of rural consumption maybe breaking.

·   In view of the threat presented by the new variant of Covid-19, many countries have recently imposed fresh mobility restrictions. This may impact exports, which has been one of the key drivers of the growth.

·  Recently, the US Federal Reserve Chairman has indicated that they may consider unwinding the bond buying program (QE) faster than previously forecasted. This faster unwinding is widely expected to result in at least two rate hikes in 2022. Back home, RBI has also started tightening money supply through OMO and other means. The tighter money supply conditions may also impact the growth in 2022.

·  As evident from the recent commentary of consumer goods companies, the persistent inflation, especially energy and food, is beginning to impact the consumption demand.