Do it yourself: Indian Economy

Showing posts with label Indian Economy. Show all posts

Wednesday, March 5, 2025

Growth normalizing in a lower orbit

As per the latest national accounts data released last week, the economic growth of India appears to be normalizing in 6.5% +/- 0.3% band. Optically, this growth rate may appear decent; but is insufficient for achieving the target of catapulting the Indian economy into a higher orbit and sustaining the status of a middle-income economy.

After recording a higher growth rate of 8.8% CAGR for three years (FY22 to FY24) on a low base of Covid affected FY20 and FY21, the FY25 growth is estimated to be 6.5%. The consensus estimates for FY26e growth are also hovering around 6.5%.

From the internals of the economic data, it appears that growth trajectory of the Indian economy is settling in the current band, just like we spent decades in the 3-4% growth band in the pre-reform (1990s) era. Any effort to accelerate the economic growth would require transformative socio-economic reforms in the next five years.

Some critical points that need to be watched closely from the perspective of growth sustainability and acceleration could be listed as follows:

· The share of primary sector that employs the largest share of workers has deteriorated from 22.1% in FY21 to 19.8% in FY25AE. The share of the secondary sector has also declined from 25.6% in FY21 to 25.2% in FY25AE. Especially, the share of manufacturing in the GDP is low at 14%, and has not recorded any material improvement despite the material incentives like PLI, etc. FY25AE growth of manufacturing is estimated to a dismal 3.5%.

· The gross savings rate of the economy has fallen to 30.2% of GDP in FY25AE, materially lower than 33.8 in FY12, when the new GDP series started. The investment rate has also fallen in this period from 39% in FY12 to 31.4% in FY25AE. The household & corporate savings and investments have seen decline in FY25E. The government investment and consumption has been supporting the investment rate to stay above 30% of GDP. The fiscal constraints are indicating that this support may weaken in the coming years.

· Early reports are indicating that Rabi crop in many states has been materially damaged by unusually dry and warm winters. Sugar production for SS25 is expected to be ~14% lower; while wheat crop may be 25-35% lower. Oilseed and pulse crops have also suffered damage. This data will reflect in 4QFY25 and 1QFY26 agriculture GVA and private consumption numbers.

It is important to note that MFI sector is already burdened by a material deterioration in the asset quality. Poor Rabi crop may add to the rural stress and adversely impact the overall consumption demand, given that urban demand is not showing signs of improvement.

It is therefore very much possible that the actual FY25E growth comes lower than the second advance (AE) estimates.

· The global trade uncertainties are rising with the passage of every hour. A situation of material trade logjam, supply chain disruption, accelerated tariff war and/or high volatility in currency markets is not completely improbable. If any such situation does materialize, it may materially hurt the growth prospects and external vulnerability of India.

Tuesday, December 3, 2024

Growth slowdown may be structural

India’s real GDP grew by 5.4% yoy during 2QFY25 (July-Sep); the slowest growth rate recorded since 3QFY23. The Reserve Bank of India had forecasted a growth of 7%, just a month ago, while the market consensus was less sanguine at ~6.5%.

For the argument’s sake, some of the slowdown in 2QFY25 could be attributed to a high base (2QFY24 GDP grew at 8.1%). However, it is tough to deny that the Indian economy has been growing below potential in most of the post global financial crisis (GFC-2009) period. In fact, it will not be totally perverse to argue that in the past one decade or so, the potential growth curve itself has moved lower.

For record, the Indian economy has grown at an average rate of 5.8% during the past decade (FY15-FY24). Even normalizing for the Covid-19 lockdown impact, the Indian economy has grown at an average rate of 6.0%, much below the estimated potential growth rate of over 8%. The real GDP had grown at an average rate of 7.8% during the preceding decade (FY05-FY14).

The slowdown in 2QFY25 has been led by the industrial sector, especially, manufacturing and core sector (e.g., mining and electricity) – a sector that has been the highest priority area for the incumbent government in the past decade. Agriculture (3.5% growth) sector did well on the back of a bountiful monsoon; and services also grew at a decent 7.1% led by public administration. On demand side, investments contracted for the fourth consecutive quarter, belying the promise of a massive jump in allocation for capex in the union budgets for FY24 and FY25. Private consumption grew 6% yoy on a low base of 2.6%, but declined qoq, despite the higher DBT.

The fiscal data for April-October 2024 period shows that contrary to its commitment in the union budget, the government has sacrificed capital expenditure in favor of direct cash transfer (DBT) to households. Ahead of key state elections, the government transferred an advance installment of tax devolution to states to meet revenue expense obligations. The central government capex (including on defense) was much lower than the budget targets. The disbursement of the promised capex loans to the states was also lower. Revenue expenditure on education, drinking water and sanitation were restrained to increase DBT allocation.

The popular narrative after the announcement of 2QFY25 GDP data appears to be that high effective rate of taxes and higher interest rates are hurting the growth and fiscal and monetary stimulus may lead to a course correction. I sincerely beg to differ from this hypothesis.

I have often highlighted that the obstacles to the acceleration in India’s growth rate are structural and not cyclical. Inability to adequately exploit our most valuable resources – the human capital and the largest pool of arable land in the world – is the principal reason for below potential growth. Consistent misallocation of capital, adhocism in policy making, lack of a conceptual growth framework, a distorted federal political structure, blatant pursuit of crony socialism, and lack of a long-term socio-economic growth plan.

In this context, it might be pertinent to note the OECD has projected a gradual deceleration in the potential growth rate of the Indian economy in the next four decades, as the marginal productivity of capital declines and contribution from technological progresses diminishes. (Table 1). The potential rate declines, even if in a blue-sky scenario, where India is able to take fuller advantage of its demography and is able to achieve a much higher rate of capital accumulation and employment (Table 2). (see full report here)

Wednesday, September 25, 2024

State of the economy

The Reserve Bank of India (RBI) has issued its latest assessment of the state of the economy. The paper notes the marked slowdown in the global economy; it exudes confidence in the sustainability of 6.7%-7% GDP growth in India. In particular, the assessment sounds buoyant on manufacturing, and household consumption, while taking cognizance of resilience in the services sector. The inflation is forecasted to stay close to the lower bound of the RBI tolerance limit (4-6%).

Global economy slowing

The RBI paper highlights some areas of concern for the global economy. In RBI’s assessment global growth has lost some speed in the first half of 2024 relative to the preceding semester, and momentum has slackened further in the third quarter.

The paper notes, “All around, indicators point increasingly to slowing global economic activity, more so on the eastern shores of the Atlantic, which vindicated the ECB’s September rate cut to secure a soft landing. In the US, the now famous remark – “The time has come for policy to adjust” – has built up expectations that the economy is gaining prominence in monetary policy discourse. In China, even though consumer inflation has picked up modestly due to supply constraints related to extreme weather, weakening producer prices are fueling concerns that deflationary forces are taking root. A rising number of manufacturing industries face lacklustre demand alongside a deep property market downturn now into its third year.” In particular—

Job growth is getting softer than initially anticipated as labour markets continue to slow down, unemployment rates are ticking up and wage growth is easing, although historically high immigration is providing some offset. Consumer confidence surveys show a deterioration in sentiment about jobs.

Equity prices are still stretched but the crash in Nvidia’s stock in early September wiped out about US$ 300 billion in market value, hinting that the artificial intelligence (AI) overhype may be tapering off and expectations are catching up with reality.

Parched returns are drying up the venture capital ecosystem. Record volumes of corporate debt are being issued to head off the volatility triggered by worsening macroeconomic data, and to benefit from falling borrowing and refinancing costs.

OPEC plus has decided to delay a planned output increase as crude prices slumped below US$ 70 per barrel briefly on September 10, but it still plans to revive 2.2 million barrels per day of idle supplies over the course of 2025. Meanwhile, non-OPEC supplies are rising faster, and as the International Energy Agency warns in its September 2024 report, global oil demand is slowing sharply – electric vehicles are already displacing 1.8 million barrels of oil every day – and this is fuelling the sell-off in oil markets. In metal markets, the copper-gold price ratio is closing on to 4 – a rising ratio indicates higher industrial demand and hence a positive growth outlook.

Although upside pressures have likely been seen off, the pace of disinflation remains sluggish, provoking caution among monetary policy authorities about the pace of easing. In fact, the Governing Council of the ECB noted in its September meeting that inflation is expected to rise again in the latter part of this year, partly because previous sharp falls in energy prices will drop out of the annual rates.

Defying gravity, global merchandise trade volume continued to recover in the third quarter of 2024, according to the latest World Trade Organization (WTO) Goods Trade Barometer, amidst rising geopolitical tensions, ongoing regional conflicts, shifting monetary policy in advanced economies (AEs) and weakening export orders. Barring the sub-par performance of electronics, other components of global trade such as automotive products, container shipping and air freight are all firmly above trend, but new export orders are turning down, and raw materials have declined – causes for concern going forward.

EMEs are building up a growth rate lead over AEs to levels not seen in 15 years. Projections suggest that the proportion of EMEs other than China in which per capita GDP is likely to rise faster than the US is on course to surge from 48 per cent over the past five years to 88 per cent in the next five years.

In the recent period, the US dollar has weakened; historically, this has led to greater capital flows to emerging markets.

The global supply chain pressures index (GSCPI) increased in August 2024, rising above its historical average for the first time since November 2023. Geopolitical risks remained high due to continued tensions in the Middle East, albeit with a sequential moderation in August 2024. Supply disruptions have kept container shipping costs elevated, although they recorded some moderation during August-September 2024 from the peak levels recorded in July.

Domestic economy

The RBI sounds quite sanguine about the domestic economic growth, regardless of the soft 1QFY25 data. The paper cautions, “more needs to be read into the slowing of India’s GDP in Q1:2024-25 than just disappointment.” It points out that “The seasonally adjusted momentum of Q1 GDP was strong. Gross value added (GVA) growth actually rose sequentially in Q1, but the increase in subsidies – 3.6 per cent by the Union government and 26 per cent by the states – offset the gains from showing up in GDP growth.”

Household consumption is poised to grow faster in Q2 as headline inflation eases, with a revival of rural demand already taking hold.

The widening trade deficit and a spurt in overseas travel by Indians is likely to swing the current account balance from a small surplus in January-March 2024 to a deficit of 1-1.2 per cent of GDP in the first half of 2024-25. Capital flows in the form of portfolio debt flows, net FDI and non-resident deposits are providing comfortable financing.

Merger and acquisitions deals have been on the decline in the Asia-Pacific region in 2024, but India has emerged as a bright spot with an increase in volumes.

Agriculture suffered in Q1:2024-25 as India experienced the highest number of heatwave days in the summer of 2024, surpassing the previous high in 2010.

The underperformance of agriculture in Q1 was compensated for by a buoyant manufacturing sector and resilient services.

Global funds have been investing heavily in the Indian debt market for the fifth month in a row since May 2024. On the other hand, corporate debt issuances remained low during the financial year so far despite easing yields as issuers awaited the US rate cut.

In the credit market, with deposit mobilization becoming a challenge, banks continue to rely heavily on certificates of deposit to meet funding needs so that lagging deposit growth does not constrain credit. Banks are also offering higher interest rates on deposits, with more than two-thirds of term deposits earning 7 per cent and above. The gap between credit and deposit growth is, however, beginning to narrow. Non-banking financial companies are increasingly turning to offshore bonds. Microfinance institutions are facing some asset quality issues, warranting slowing down the pace of loan growth.

Headline CPI inflation came in below the Reserve Bank’s target for the second consecutive month in its August reading. This is a positive development, especially as the index has remained flat between July and August.

Surplus liquidity in the banking system moderated in the latter half of August, driven by build-up of government cash balances due to GST payments. In early September, however, a pickup in government spending led to the return of liquidity to the banking system. Overall, the average daily net absorption under the liquidity adjustment facility (LAF) decreased to ₹1.45 lakh crore during August 16 to September 17, 2024, from ₹1.52 lakh crore during July 16 and August 15, 2024.

Tuesday, January 9, 2024

USD five trillion in 2029

Last week the National Statistical Office (NSO) released its first advance estimates (FAE) of the national income for the current financial year 2023-24. The growth in real GDP during 2023-24 is estimated at 7.3% as compared to 7.2% in 2022-23. This projection of growth is higher than the latest forecast of the Reserve Bank of India (7%) and professional forecasters (6.0 to 6.9%). Given the economic momentum, it is likely that growth for the next financial year FY25, currently pegged ~6.5%, may also get revised upwards.

As per FAE, the Nominal GDP (GDP at Current Prices) in the year 2023-24 is estimated at ₹296.58 trillion (USD 3.56trn), as against the Provisional Estimate of GDP for the year 2022-23 of ₹272.41 trillion. The growth in nominal GDP during 2023-24 is thus estimated at 8.9%, much slower than 16.1% in 2022-23.

It is critical to note that most statistical numbers relevant to the financial market investors are benchmarked to the nominal GDP. For example, corporate profits, tax collections, fiscal deficit, wage growth, and government borrowings are correlated to the nominal GDP. Market capitalization to GDP, a popular stock market gauge to assess overheating (or otherwise), also uses nominal GDP as a denominator. A slower nominal GDP growth therefore could impact many of these parameters adversely.

Some of the key points worth noting in FAE are as follows:

· Consumption has slowed down considerably. Private consumption is estimated to be 56.9% of real GDP (58.5% in FY23 and 58.6% in FY22) and Government consumption is estimated to be 9.6% of real GDP (9.9% in FY23 and 10.6% in FY22).

Per capita real consumption expenditure in FY24 is estimated to be Rs70,065, a growth of 3.5% over FY23. This is one of the lowest real consumption growth rates in many years.

Per capita Real GDP is estimated to be Rs1,23,144 (USD1479), a growth of 6.4% over FY23.

Considering that per capita real GDP is estimated to grow at 6.4%, there is a deceleration in the propensity to consume. In FY23 per capita consumption grew 6.4%, higher than the 6.1% growth in per capita real GDP. It would be interesting to see whether the lower propensity to consume is due to a sharp rise in inequality of income or a higher propensity to save.

In nominal terms, there is no noticeable change in consumption as compared to FY23.

· The share of Investments in GDP continues to grow. Gross Fixed Capital Formation (GFCF) is estimated to be 34.9% of real GDP (34% in FY23 and 32.7% in FY22).

In nominal terms, GFCF is estimated to be 29.8% (29.2% in FY23).

· Trade deficit to widen. Exports will likely slow down to 22.2% of real GDP (23.5% in FY23) while imports may grow faster to 26.9% of real GDP (25.6% in FY23).

In nominal terms, however, imports are estimated to slow down to 23.7% of GDP (26.4% in FY24.

· Agriculture crashes, manufacturing & construction lead the growth. Agriculture and allied sectors are estimated to grow 1.4% (4% in FY23). Rice production is estimated to fall 5.4%.

Manufacturing growth recovers to 6.5% (1.3% in FY23). Construction sector growth sustains at 10.7% (10% in FY23).

Trade, hotel, transports and communication sector growth slows down to 6.3% (14% in FY23).

It is noteworthy that nominal growth in manufacturing is slower at 4.4% as compared to 7% in FY23. WPI of manufactured goods is estimated to deflate -2% against 7.5% inflation in FY23.

· Higher indirect taxes. In real terms, Net taxes on products are estimated to grow by 12.5% (10.1% in FY23)

·
USD 5trn in 2029. If the nominal GDP of India grows at a CAGR of 7%, net of USDINR depreciation, India will be a USD five trillion economy in five years, i.e., by the end of FY29. A faster growth or USDINR appreciation can take us there a couple of years early, maybe.

Friday, October 20, 2023

Some notable research snippets of the week

WPI in Contraction for the Sixth Month; core inflation higher (Centrum)

WPI inflation witnessed a yet another contraction in the month of September and registered a deflation of 0.26% YoY, down from -0.52% in August. The print came in slightly lower than the estimates as the general consensus was around -0.5%. This was the 6^th month where we have seen a contraction. All the segments witnessed a deflation in prices, except for the Primary Articles. However, on a monthly basis primary articles contracted while Fuel & Power and Manufactured products saw rise in prices.

Core inflation rose in September

India’s WPI based inflation witnessed a further contraction in August. The persistent moderation in WPI since May-22 has been mainly because of constant decline in mostly all the major sub-indices. Although at a slower pace than previous month, this month’s fall in the wholesale prices can be mainly attributed to all the sub-indices except for the primary articles, as food prices (although slowing down) remains in the positive. The deflation in Fuel prices have slowed down as international crude prices have again started to pick up. We expect food prices to cool down in the coming months, all while fuel prices may turn out to put pressure on the headline WPI figures. The core prices remained in deflation for the 7^th consecutive month as it fell by 1.4% compared to 2.2% in the month of August.

September’s report clearly shows that the inflationary pressure caused by high food prices have eased down considerably - which clearly indicates a good sign for the market. However, production cut done by Saudi Arabia and Russia could hurt the prices further on the upside. Clearly, the tightness forced by the RBI has started to show, as both core CPI and WPI are on a downtrend, which eliminates the volatile fluctuations of food and energy prices. This report came after the CPI recorded a print of 5.02% for the month of September, which took a detour from the 7.44% it had hit in the month of July.

Narrowed trade deficit a transient respite (Systematix)

India’s trade deficit narrowed in Jul’23 on the back of a sharper decline in imports than exports. But it reflects slowing demand and global trade. As trade was the biggest driver for post-pandemic recovery, the receding global bounties are having a wider impact on the domestic economy, particularly the employment-intensive services sector. While RBI has the buffer in the form of forex assets, the spillovers of external sector vulnerabilities can manifest into volatile currency and rate markets.

Overall trade reflective of slowing global and domestic demand: At the segregated level, the oil trade has been contracting since Mar’23 by 20% (YoY) on average. Non-oil & and non-gold/silver trade has also contracted by 5.9% (YoY) on average since Dec’23. This is reflective of simultaneously slowing global trade and domestic demand.

Contracting services trade has a larger bearing: With the current declining trend of the overall trade since its peak in early 2022, it is going to have a multi-layer cascading impact on the formal sector. Overall services trade and its components, which remain a significant source of formal and informal employment, have started exhibiting signs of moderation or contraction.

India strategy: Global headwinds to test domestic resilience (AXIS Capital)

Indian equities should be able to offset some of the downward pressure emerging from the downward adjustment in valuation of global financial assets due to the sharp rise in risk-free rates (UST yields). Not only are inflows into domestic MFs likely to be resilient, EPS growth and revisions are both supportive of time correction. With a cyclical upturn in capital formation supporting the structural improvements in labour and productivity growth, the domestic economy should also be able to offset some of the headwinds from the ongoing global slowdown. A sharp US recession, though, can drive a spike in risk premia and also intensify growth headwinds for the economy.

Structural drivers likely to drive 7% growth annually

We believe India can grow at ~7% annually, with 1% growth in labor input supplementing 2%-plus growth in total factor productivity. We expect strong TFP growth to continue (2.4% CAGR in the five years pre-Covid), on (1) the state continuing to cede space to the private sector (the latter generally uses labour and capital better); (2) improving macro (roads, highways, airports, ports) and micro (last-mile access to energy, piped water, internet and financial services) infrastructure; (3) formalization of retail and construction; (4) net services exports; and (5) state capacity improving.

Improving capital formation to provide cyclical boost, offset headwinds

The pre-Covid growth slowdown was due to a fall in growth of capital formation (bad-loan clean-up and a real-estate downcycle). This is now changing: dwelling construction is picking up, and leverage on corporate balance sheets and lenders has likely bottomed out. These should offset the several cyclical headwinds faced by the economy.

The first is limited fiscal space and a falling fiscal deficit ratio. Second, even with a pause on repo rate hikes, financial conditions can continue to tighten as loans roll over. Third, as the global economic slowdown is already hurting growth in goods and services, a likely US recession next year can intensify pressure in some of the export-driven sectors.

Real-estate cycle turning after a decade-long downturn: No sub-continental sized economy like India can grow rapidly without strength in dwelling construction. Despite 2.4% annual growth in household formation (Exhibit 28:), a houses-to-households ratio of 0.97 in 2019, 4% annual growth in the size of houses (the floor space per person in India is ~100 sq ft, vs 550 in China and 700 in the US, Exhibit 29:), and rising quality of construction, the value of dwelling construction in India barely grew over 2012-21.

Time correction for now: lower global P/Es, and steady EPS growth

The US Treasury (UST) yields have risen 2 pp, and are likely to remain elevated, in our view. With Nifty earnings yield spread over UST yields at record lows, P/E can remain under pressure despite the USD 30-35bn of unintended flows into domestic equity MFs.

P/E premium to world is already elevated at 30%. Markets may time-correct as Nifty earnings are in much better shape than in the past decade: (1) for-the-year EPS seeing upgrades vs sharp 10-25% cuts in the prior decade; and (2) double-digit growth FY24-26E vs 4% CAGR 2011-20. In our 30-stock model portfolio, we are overweight financials, autos, utilities, cement, and real-estate, and underweight IT, industrials, and metals.

US bond yields may remain elevated (MOFSL)

During the past three months, the benchmark 10-year US treasury yield has surged toward 4.75%, about 100bp higher than the mid-Jul’23 level. Notably, the rise in the yield is not limited only to the longer end, but it is seen across the curve and more at the shorter end, as the spread between the 3-month yield and the 10-year yield has actually narrowed from -1.5pp in mid-Jul’23 (and 4-decade low of -1.89pp in early Jun’23) to -0.9pp in Oct’23, last seen in early 2023. (All data used here is as of 16th Oct’23).

If the cost of funds increases sharply and continuously, it is usually believed to hurt borrowers. Nevertheless, since a bulk (~90%) of household loans are fixed-term, higher rates have not pinched customers in the US. Because of this, the burden of higher interest rates will be borne by the lenders, due to the higher cost of roll-over and/or refinancing the loans. On top of this, the financial institutions also see a drop in the value of their securities portfolios due to higher interest rates.

Moreover, although higher rates may not affect existing customers, they are likely to affect new demand badly, hurting home prices. This, if happens, will have the potential to broaden and sharpen the economic slowdown. However, mortgage/non-mortgage loans continue to grow decently, which shows that consumers are not worried so far.

None of these troublesome implications, thus, have played out so far. Our expectation of a serious US slowdown by mid-2023 did not materialize, and even the soft landing theory has been elusive. The US economy remains strong, supported by the drawdown in savings by US consumers, which is in contrast to most other rich nations.

However, this is unlikely to continue for a long period, especially if bond yields stay so elevated. Only ~8% of the market participants expect a rate hike on 1st Nov’23, down from 33% a month ago, and 29% expect it in Dec’23 (up from 2.3% a month ago). It means that the majority of participants would be surprised if the US Federal Reserve delivers another rate hike, like they projected in their Sep’23 policy meeting.

We believe that even if the Fed does not hike rates in the next meeting, it cannot afford to loosen its stance. If so, bond yields will remain elevated, and the longer they stay high, the higher the risk of an economic slowdown is. Accordingly, we push our expectation of a US economic slowdown into 1HCY24.

Unrealized losses of the financial institutions have surged

If the cost of funds increases sharply and continuously, it is usually believed to hurt borrowers. Nevertheless, since a bulk (~90%) of household loans are fixed-term, higher rates have not pinched customers. Because of this, the burden of higher interest rates will be borne by lenders, due to the higher cost of roll-over and/or refinancing the loans. On top of this, financial institutions also see a drop in the value of their securities portfolios due to higher interest rates.

According to the Federal Deposit Insurance Corporation (FDIC), the unrealized losses on investment securities of all the FDIC-insured institutions in the US have amounted to close to or more than USD500b during the past five quarters. Since the Fed started hiking interest rates in Mar’22, unrealized gains have disappeared (from USD29.4b in 3QCY21) and large losses (totaling USD558b in 2QCY23) have emerged. The unrealized losses are divided in the ratio of 45:55 between available-for-sale (AFS) and held-to-maturity (HTM) securities portfolios.

We are not suggesting that all these losses will be realized. However, it is probable that some institutions may be forced to unwind their positions unwillingly, making it economically very difficult for them to survive. Overall, it may not bring down the entire financial sector, but it definitely holds the potential to send chills. Of course, timely intervention by an extremely active US Fed could change the course.

Steel demand to grow slower than expected (Centrum)

World steel association in its October 2023 outlook revised steel demand growth estimate to 1.8% in 2023 and reach 1,814.5mt downgrading from 2.3% YoY earlier. As steel using key sectors like infrastructure and construction witnessing impact of high inflation and high interest rate leading to slowdown in both investment as well as consumption. However, recovery in auto production continued in 2023, helped by order backlog and easing of bottlenecks resulting high growth for most regions. For CY24, world steel demand is expected to show 1.9% YoY growth led by demand improvement in World ex China.

China - The real estate sector have shown state of weakness as key indicators like land sales, housing sales and new construction starts continued to fall in 2023. However, government infrastructure spending stood as major driver for steel demand. As a result, steel demand is expected to rebound by 2% YoY at 939mt in CY23 after fall of 3.5% in CY22. The various measures undertaken by the government should lead to stabilisation in property sector. Hence, under this assumption, the steel demand for CY24 is expected to sustain at CY23 level.

India - India remains bright spot in the global steel industry benefiting from surge in construction and infrastructure sector driven by government spending as well as recovery in private investment. After growing by 9% in CY22, demand is expected to show healthy growth of 8.6% in CY23 and 7.7% in CY24.

US - Despite the resilience of the US economy to steep interest hikes, steel using sectors are feeling demand slowing down. Particularly, residential construction is affected, which is expected to contract in 2023 and 2024. Manufacturing has been also slowing, but the automotive sector is expected to continue its post-pandemic recovery. The lagged effect of tight monetary policy points to downside risk for 2024. After a fall of 2.6% in 2022, steel demand is expected to decline by 1.1% in 2023 and then grow by 1.6% in 2024.

European Union and UK - In CY23, EU economy stood stronger than expected to able to manage energy crisis arising from the Russia-Ukraine war. The high interest rates and energy costs had heavy effect on manufacturing activities. Though, recovery in automotive sector continued. The steel demand after a fall of 7.8% in 2022, is expected to fall by 5.1% in 2023. Although in CY24, demand is expected to see rebound as impact of current adversaries likely to cool off.

View & Outlook: Developing nations to spearhead global steel demand

Overall, worsening economic outlook due to influence of monetary tightening that hurt consumption and investment alike. The construction sector has been negatively affected by the high interest rates and high-cost environment, especially the residential sector. Falling housing sales have led to financial troubles for major Chinese real estate developers, generating concerns about the health of the economy. For CY2024, auto sector growth likely to decelerate, China to remain uncertain depending on the policy direction to tackle economic difficulties, regional conflicts such as Russia-Ukraine, Israel-Palestine and elsewhere further add to downside risk. Steel demand dynamics in emerging and developing economies continue to diverge, with developing nations excluding China remaining resilient to global headwinds. After falling by 0.6% in 2022, steel demand in emerging and developing economies excluding China will show growth of 4.1% in 2023 and 4.8% in 2024.

India metals - Earnings to be a mixed bag (Systematix)

India’s steel production and demand remained strong for a seasonally slow quarter. Domestic crude steel production increased by 15% YoY during July-August 2023 while other major economies witnessed a decline over the same period. Various economic indicators also signal strong demand from the infrastructure, building and construction, and automotive sectors, a trend likely to gain momentum in 2HFY24. Prices of major base metals fell during 2QFY24, with zinc/aluminium recording a decline of 25.7%/8.6% YoY and 4.5%/5.2% QoQ. Lead and copper prices were relatively resilient at USD 2,170/t (+9.8%/+2.5% YoY/QoQ) and USD 8,356/t (+7.9%/-1.5% YoY/QoQ), respectively. Silver/gold prices slid lower by 2.5%/2.7% QoQ but remained higher by 22.6%/13.3% on a YoY basis, respectively.

Primary steel producers under our coverage (JSW Steel, SAIL, and Tata Steel) are estimated to report a 3%/1% YoY/QoQ drop in 2QFY24 revenue due to lower steel prices and seasonal factors. However, despite seasonality, the EBITDA margin is likely to remain stable driven by higher volumes and lower raw material costs.

Strong domestic demand is likely to keep the earnings buoyant for JSW Steel and Tata Steel, partially offsetting the impact of lower sales volume estimated at their respective international operations. We estimate strong sales and EBITDA recovery for SAIL driven by 13%/5% YoY/QoQ growth in 2QFY24 reported production.

Mining companies MOIL, NMDC, and Coal India are likely to report a YoY EBITDA growth of 28% driven by strong operational performance. APL Apollo Tubes (APAT) and Surya Roshni (SYR) are estimated to report EBITDA growth of 29% and 19% YoY, respectively, driven by high-margin value-added product portfolio and higher volumes partially offsetting lower steel prices. For our non-ferrous coverage (Hindustan Zinc, Vedanta, and NALCO), we estimate a YoY/QoQ drop of 21%/3% in EBITDA reflecting the movement in base metal prices. Overall, we estimate 2QFY24 EBITDA of our metals and mining universe to increase by 13% YoY but decline by 5% QoQ. We currently have BUY on SAIL, TATA, JSTL, MOIL, NALCO, SYR, NMDC, COAL, and VEDL, and HOLD on APAT, and HZL.

Strong domestic demand: India reported a 17% YoY growth in monthly crude steel production in August 2023, and remains one of the few countries globally to consistently record growth in steel production. India’s September 2023 manufacturing PMI came in at 57.5, above the neutral level of 50 for the 27^th consecutive month, indicating strong order intake and sustaining demand.

The latest Index of Industrial Production (IIP) data for manufacturing activity in basic metals also indicated a strong demand scenario, as it increased to 215 in August 2023 vs 207.7 in July 2023 (2011 as the base year). Strong demand, increasing volumes, and lower raw material costs are likely to outweigh the impact of lower steel prices and help key ferrous companies maintain EBITDA margins during the quarter. We believe, earnings have already witnessed a significant pullback in 1QFY24 as key metal prices normalised from the record levels breached during the same period last year and, going forward, higher volume-enabled operating leverage will ensure margin sustenance while higher demand keeps prices in check.

Rising exports disaffirm overcapacity risk in China; will likely keep steel prices

rangebound

Steel demand from the property sector in China, largest steel producing country, remained subdued during the quarter slashing hopes of a faster economic recovery. However, expected steel production cuts have not materialized as well due to an offsetting demand from the infrastructure and manufacturing sectors. China’s PMI data showed expansion in September 2023, after recording a contraction in manufacturing activity for two consecutive months. Lack of domestic demand from the property sector has also led to a rise in steel exports from China. During April-July 2023, China produced 364.6mt of crude steel, a marginal increase of 0.36% from last year. Over the same period, exports of finished steel to India increased by 27% and 58% YoY in value and volume terms, respectively. We believe, China is likely to take milder production cuts for the rest of the year due to concerns over economic growth that would keep exports high and inventories at a comfortable level thus providing downside support to steel prices.

Thursday, August 24, 2023

State of Affairs – Macroeconomic conditions

Recently, the Reserve Bank of India published the results of the 83^rd round of the Survey of Professional Forecasters. In the latest Survey, professional forecasters have mostly reiterated their previous estimates. The forecasters have assigned the highest probability of the real GDP growth remaining between 6.0% and 6.4% during FY24 and FY25. No significant acceleration is expected in the growth in FY25.

The FY24 growth is seen to be mostly front-ended, with the real GDP expected to grow (y-o-y) by 7.5% in Q1FY24 and thereafter moderate to 6.2% in Q2, 5.9% Q3, and further to 5.5% in Q4. The participants were quite sanguine about the price condition remaining under control with CPI inflation averaging 4.7% in FY25. The trade situation is expected to deteriorate further in FY24, before recovering in FY25. The trade deficit is likely to be close to 1.5% in FY24 as well as FY25. No significant improvement is expected in investment and savings rates.

The key highlights of the latest survey of professional forecasters are as follows:

Growth

The real GDP may grow by 6.1% in FY24 and 6.5% in FY25. The growth in FY24 would be mostly front-ended with 1QFY24 expected to record a growth of 7.5%.

Private Consumption is expected to grow 6.1% in FY24 and 6.4% in FY25.

Investment may grow at 7.1% in FY24 and 7.4% in FY25. The investment rate maybe 31.1% of GDP in FY24 and 31.5% in FY25

Gross Savings Rate is expected to be 29.8% of National Disposable Income in FY24 and 29.9% in FY25.

Fiscal Situation

The fiscal deficit of the central government is projected to be 5.9% for FY24 and 5.4% for FY25. Total gross fiscal deficit (center + states) is expected to be 8.7% and 8.2% for FY24 and FY25 respectively.

Benchmark 10-year bond yields are projected to average 7% in FY24 and 6.6% in FY25.

Trade and balance of payment

The current account balance is forecast to be negative US$52.6bn (1.4% of GDP) in FY24 and US$61.7bn (1.5% of GDP) in FY25.

Imports may contract by 5% in FY24 and grow by 7.8% in FY25.

Exports may Contract by 5.5% in FY24 and grow by 7% in FY25.

Overall balance of payment surplus is expected to be US$24.1 in FY24 and US$16bn in FY24

Inflation

The headline CPI inflation is likely to average 5.2% in FY24 and 4.7% in FY25.

The WPI inflation may average 0% in FY24 and 4% in FY25.

Thursday, August 17, 2023

Will 2025-2035 be India’s decade?

The tremendous economic growth achieved by Japan in the post-WWII era is popularly known as “The Japanese Economic Miracle”. It was in fact nothing less than a miracle – a country totally devastated by war rose from ashes to become one of the largest economies in the world. Japan recorded a high rate of economic growth during 1950-1975. The growth was primarily led by strong capital accumulation, strategic initiatives to expand trade share in global markets, concentration on technology development & innovation, and development of a strong high-quality ethical workforce.

Supported by benign monetary policy, easy credit, and profligate fiscal policies, by the end of the 1970s, Japan had become a powerhouse of technology and finance. The 1980s however witnessed unprecedented heating of the Japanese economy. Asset prices ballooned to unsustainable levels. The Bank of Japan, in its wisdom, decided not to tighten the monetary policy to control the surging asset prices. Low rates and a stronger JPY, led to a prolonged phase of low growth and low inflation. Worsening demography, due to a variety of reasons, further exacerbated the deflationary pressures in the economy. 1990-2020 witnessed Japan struggling with low inflation and low growth. The Global Financial Crisis and Covid-19 pandemic made things only worse.

The present state of the Japanese economy has become a generic reference for economies struggling with low growth, low inflation, low rates, and high debt for a prolonged period; and is referred to as “The Japanification of Economy” in the popular economic lexicon.

Post the Global Financial Crisis (GFC) in 2008-09, the fears of Japanification of several global economies increased. Unprecedented monetary easing in the wake of Covid-19 further enhanced the risk of a prolonged phase of low growth in several developed and developing countries.

In the past couple of years, we have witnessed a strong spike in inflationary pressures across the globe. Initially, it was believed that this episode of inflation is mostly a consequence of supply-chain issues, which broke down badly due to the pandemic; hence it would be transitory. However, later it emerged that it may be more structural than transitory.

The quantitative easing in the wake of the GFC did not cause consumer inflation, because money printed during 2009-2011 was mostly given to banks, which did not lend much of it to consumers. The velocity of money remained very poor; thus the actual money supply did not increase materially. But during Covid-19, a large chunk of new money flowed into the hands of consumers increasing demand at a time when supply was seriously constrained. High inflation was a natural consequence. Erratic weather conditions globally and a war between Russia and Ukraine (major suppliers of energy and food to Europe in particular) added further to the food and energy inflation.

In the past fifteen months, the central bankers globally have tightened the money supply and efforts have been made to add production capacities to meet incremental demand. It seems for now inflation has been controlled; though the inflationary expectations remain high as it is commonly believed that slower growth and financial crisis (that looks imminent) would force central bankers to open the liquidity taps again – sooner than later.

Nonetheless, for now, Japanification of the US and Europe has not happened as inflation remains high, rates have been hiked and recession has been avoided.

On the other hand, the conditions in China eerily resemble the conditions in Japan during the early 1990s. After two decades of massive growth led by huge investments in technology, infrastructure, and manufacturing capacities, the Chinese economy is feeling the fatigue. The population is aging and employment conditions are worsening. The growth rate is consistently declining. The real estate market is in a bubble-like situation, with several defaults and a huge inventory. China is the only major economy, besides Japan, that has not cut rates in the past decade. Inflation continues to remain low. The financial institutions are weakening and fiscal support to consumers and the financial system remains high.

The risk of the Japanification of the Chinese Economy is real and material. Considering that China has been a major driver of global growth in the past couple of decades, a Japanified China cannot be good news for the world as a whole. However, on the positive side, it may be an excellent opportunity for India that may get favorable conditions for growth – what Japan got in two decades post WWII and China got after its admission into WTO.

Wednesday, May 31, 2023

India: An economy under transformation

Last week I had written (see here) about how the fourth letter of the English Alphabet “D” has gained prominence in the financial market jargon. In particular, I find three “Ds”, viz., Digitalization, Deflation and Demographics most relevant for the economy and therefore markets.

A recent speech of Dr. Michael Patra, Deputy Governor of RBI, as published in the latest monthly bulletin of RBI (May 2023), highlighted some more ‘D” factors that are ushering India into a new age. Besides demographics & Digitalization, Mr. Patra emphasized on Diaspora, Diversification, Diplomacy, Dynamic Federalism, and Decarbonization as key factors in transformation of the Indian economy. The following are some excerpts from his speech:

Diaspora: An outward reflection of India’s demographic bonus is the vibrant expansion of Indian communities across the world. Over the years, our perceptions about the diaspora have also transformed from ‘brain drain’ to ‘brain gain’, spurred by the contributions that Indians have made in various fields in the global arena, including information technology, entrepreneurship, international politics, medicine, arts and culture, with some of them becoming Nobel laureates. It is estimated that over 90 out of 1078 founders of about 500 unicorns in the US are persons of Indian origin.

The Indian economy has been a beneficiary of this dynamic and industrious diaspora. India currently receives the highest flow of remittances in the world at US $ 108 billion in 2022, up by 24.6 per cent from a year ago, and accounting for 3 per cent of India’s GDP. Additionally, Indians residing abroad hold deposits in Indian banks cumulating to US $ 136 billion at the end of February 2023.

Diversification: The Indian economy is undergoing a quiet but fundamental transformation encompassing all its sectors. Perhaps the most striking transformation is occurring in India’s exports of services which have demonstrated pandemic-proofing, rising by above 25 per cent per annum since 2020, and providing valuable support to the viability of the external sector. While software and business services are the main drivers of this robust performance, advances in IT have not only made services more tradable but also increasingly unbundled: a single service activity in the global supply chain can now be fragmented and undertaken separately at different geographical locations. Jurisdictions have accordingly been decentralising and diversifying their supply chains to ensure business continuity. These factors have led to a new channel of IT-enabled services - large multinational corporations (MNCs) are setting up Global Capability Centres (GCCs), which are offshore offices, delivering a wide array of services across IT sector verticals.

India is also becoming a hub for engineering R&D (ER&D) centers as leading multinationals develop their centers of excellence (CoEs) across different business domains. The National Association of Software and Service Companies (NASSCOM) estimates that India will add 500 GCCs by 2026. They are going to be hiring. India’s citizens of the future should prepare for this revolution. The world is coming to our doorstep to fill world-class jobs.

Diplomacy: India is prioritising a reformed multilateralism that creates a more accountable, inclusive, just, equitable and representative multipolar international system for the 21st century. Our priorities include addressing the macroeconomic implications of food and energy insecurity; climate change; strengthening Multilateral Development Banks (MBDs); debt sustainability; strengthening financial resilience through sustainable capital flows; financing inclusive, equitable and sustainable growth; leveraging digital public infrastructure; climate financing; and opportunities and risks from technological change.

Dynamic Federalism: Increasingly, the quality of life and the business environment in India is going to be defined by shifts in the focus of public policy that foster competitive federalism among India’s states in achieving the aspirational goals of sustainable economic development. The freedom to compete allows each state to design, experiment, innovate and reform, given its unique features and challenges, while emulating best practices achieved by peers. An example of the power of competitive federalism is the drive among states to attract private investment, both domestic as well as foreign, by showcasing investment opportunities in each state. The spirit of competitiveness is being promoted at the highest policy levels.

As our states compete for a place in the sun, they will nurture business growth, put in place the best physical and social infrastructure and provide us with improved basic amenities, clean energy, and better health and societal outcomes. Along with foreign investment bringing in new technologies and ideas, we are moving into a national ethos of wider consumer choices and a better standard of living.

Decarbonisation: India and other developing economies are highly vulnerable to climate change due to their limited capabilities in climate science and technology and insufficient funding for adaptation and mitigation. The relative costs of transitioning to a greener path are higher for them than for the advanced economies; undertaking the transition can even push them several places down the development ladder. From the developing world, India has emerged as a leading voice on global climate action that is mindful of climate equity and justice considerations.

India has co-founded the International Solar Alliance (ISA) with France in 2016 and announced a National Hydrogen Mission to increase the dependency on green energy. The Mission LiFE, i.e., Lifestyle for the Environment, launched in 2022, is now a global movement to connect the powers of the people for the protection of the earth.

Dr. Patra ended his speech by invoking Victor Huge’s words- ““Nothing else in the world…not all the armies…is so powerful as an idea whose time has come.” He, like millions of us, too believes that India’s time has come and we must seize it. There are formidable trials and challenges ahead, but they can be overcome if we exploit the comparative advantages.

Friday, April 28, 2023

Some notable research snippets of the week

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.