Vijay Kumar Gaba: India GDP

Friday, February 28, 2020

Lower crude prices not necessarily good for economy and markets

In past few days many market experts have highlighted that the recent fall in crude prices is a major positive for Indian economy. Through my interactions with some investors I learned that many investors do take the publically expressed random opinions of these experts quite seriously and actually base their decisions on these.

Besides, small investors are also usually seen following the actions large celebrity investors. Even in recent past, there have been many instances where small investors have emulated the actions of large investor buying a meaningful stake in a stressed asset.

From the regulatory standpoint there is no violation in both these cases. The market experts are free to publically express their opinions and views about the market trends and events. The companies, stock exchanges and investors are in fact obligated to make public disclosure of large secondary market deals. But there could be an ethical lacuna in these practices.

For example, one reputed fund manager, who presently runs an investment management and advisory firm and had been CIO of one of the top AMCs in the country, recently tweeted "$40 for crude in 2020 coming soon. Big positive for India!"

Obviously he made this assertion in zest and may not have any particular design in mind while writing this tweet at midnight. However, his numerous followers may find it an "advice" and accordingly act upon it.

It would therefore be better if the "experts" had also highlight that crude prices usually have positive correlation with India's GDP growth. In past 20yrs, all three episodes of sharp rise in crude prices have resulted in rising trend in India's GDP growth rate, and vice versa.

2004-2007: Brent Crude prices jumped from under $30/bbl to over $140/bbl. In this period India's GDP growth accelerated from about 3% (FY03) to 9.5% (FY08).
2010-2012: Brent crude prices again jumped from $40/bbl to $$120/bbl. In this period, India's GDP growth improved from 5.5% in FY13 to 8.25% in FY12.
2016-2017: Brent crude prices jumped from below $30/bbl to over $80/bbl. In this period also India's GDP growth improved from 7.5% in FY15 to 7.75% in FY17.

It would be pertinent to note that crude prices fall in response to demand slowdown. A fall in crude prices has not particularly shown to be pushing the growth higher. Besides, the Indian markets have not shown any significant correlation with the rude prices in the past.

Lower crude prices hurt many businesses like oil & gas producers and oil marketing companies.

Lower crude prices hurt state revenues (excise and customs) which are ad valorem to crude prices. Since the fuel pricing is not market driven and subsidies have been virtually eliminated, the offsetting positive impact on fiscal in form of lower subsidies is no longer available.

Moreover, if the crude prices are falling due to demand slowdown, the benefit to the consumer industries is limited as they are not able to increase production at lower cost. So lower crude prices may help in protecting margins to some extent during the demand slowdown period, but may not necessarily result in higher profits.

It may be noted that sharp fall in crude prices in 2008-09 and 2014-16 did not result in any major gains for Indian stock markets.

Friday, January 10, 2020

Thoughts on FY20 GDP advance estimates - 2

As I indicated yesterday (see here), the advance estimates of FY20 GDP are at significant variance from the estimates used for the setting budget targets in July.

The union budget for FY20 presented in July 2019 has apparently estimated nominal GDP growth at 12.2% for the purposes of calculating deficit and revenue. A 40% lower nominal GDP growth could distort the entire fiscal maths of the government. For example, consider the following:

The union budget estimated the central fiscal deficit for FY20 to be Rs7.04trn or 3.3% of the GDP. This implies a nominal GDP of Rs213.26trn. As per the revised estimates, the nominal GDP for FY20 may be Rs204.42trn only.

As per the latest reports (see here) the actual fiscal deficit of the central government was already at Rs7.53trn (or 3.7% of the advance estimates of GDP) by the end of November 2019.

This implies any one or more of the following three scenarios materializing:

(i) The government tightens its belt during 4QFY20 by drastically cutting public consumption and investments. In this scenario, the GDP growth may slip a further down since in first 3qtrs only higher public expenditure has supported the growth. The government has in fact already provided some indications of cutting back on expenses. (see here)

(ii) The government may relax the fiscal deficit targets and settles for a higher fiscal deficit number. Given the poor GST collections, many states have already requested relaxation in the FRBM targets for FY20. In this case the pressure on bond yields shall remain high and the scope for further easing by RBI may get limited.

(iii) The government is forced to delay payments and refunds thereby further pressurizing the working capital cycle of the businesses.

The full impact of the corporate tax rate cuts announced in August is not known and needs to be adjusted in the revenue assumptions of the budget. Besides, slower growth means poor corporate profitability.

The government had budgeted Rs7.66trn of corporate tax collections which is equivalent to 3.6% of nominal GDP estimated in the budget making. If we assume a pro rata fall, the corporate tax collection (without accounting for the tax rate cut impact) may not be more than Rs7.34trn.

Accounting for corporate tax cut impact, the actual situation may be worse.

The manufacturing and construction sectors have witnessed the worst slowdown. Given that Automobile and Cement are major contributors to the GST collections, the chances are that GST collection shall fall materially short of the budget estimates.

This essentially means much lower transfer of resources to state governments and local bodies as compared to the previous estimates. This shall strain the finances of state government and also the debt rating (...and cost of debt) for the state governments and local bodies

Given the lower denominator, the statistics like Debt to GDP, Market Cap to GDP and Subsidies to GDP look much worse than previous estimates. The target to bring subsidies to 1.3% of GDP by FY21 may also be missed.