Vijay Kumar Gaba

In the past one year, inflation has been one of the primary concerns for most countries across the globe. Rising prices of food and energy in particular have materially impacted the lives of common people on all continents. The central bankers of most major economies have hiked policy rates in the past one year to control inflation. In the current year 2023 so far, 13 major central bankers have taken policy action(s) and all of these actions have been hike in policy rates.

However, in recent weeks inflation has shown some tendency of cooling down. It is difficult to assess how much of this cooling down is due to tighter monetary conditions; and how much could be attributed to other factors like restoration of supply chains that were broken during the pandemic and warmer winters resulting in lower energy demand in the northern hemisphere, etc. Nonetheless, some central bankers have adjusted the pace of tightening to smaller hikes. Most of them, though remain circumspect about the persistence of inflation. While the debate continues over the trajectory of price hikes in the next few quarters; an overwhelming majority of experts believe that prices may remain high for much longer.

The global growth forecasts have witnessed some downgrades in the past six months as tighter monetary conditions and higher prices are seen hurting demand for consumption and investment. As per the latest assessment of the World Bank, in 2023 “the world economy is set to grow at the third weakest pace in nearly three decades, overshadowed only by the recessions caused by the pandemic and the global financial crisis….Major economies are undergoing a period of pronounced weakness, and the resulting spill-overs are exacerbating other headwinds faced by emerging market and developing economies (EMDEs).” 

With this background, three key issues that could influence the future trajectory of global prices and therefore interest rates are geopolitical situation; impact of China ending Covid restrictions and the impact of the emergence of El Nino on global food production.

Geopolitical conflict in Eastern Europe (Russia-Ukraine) has materially influenced the prices of energy and food in the past one year. Any worsening or this conflict or expansion to Western Europe could make things worse. Some events in the recent weeks have indicated that Sino-US relations may not improve anytime soon. NATO countries hardening their stand on Russia; Russia retaliating with a cut in energy output; and some key OPEC members openly expressing disagreements with US oil pricing has materially increased the uncertainty in the energy market.

China has been gradually relaxing the covid restrictions for the past many months. This has eased the logistic logjam across the world. The supply chains that were broken due to congestion at major ports, shortage of containers, short supply of key raw materials, and poor take-off have mostly been repaired. The freight rates that had become prohibitively high have eased to pre Covid (2019) levels. The debatable question however is whether China reopening will be inflationary (higher demand) or deflationary (complete supply chain restoration and consequent destocking; improved mobility of workers etc.).

As per the latest forecast of various weather agencies (see here), the probability of El Nino conditions developing in the coming summer could impact the agriculture production in major countries like India, this year. If these forecasts come true, we may see food prices remaining at elevated levels.

A variety of views prevail on these three issues and their outcome. In my view, China reopening will indubitably be deflationary for the global economy, especially metals and other raw materials).

I am however not sure about the geopolitical conditions. I would therefore continue to expect elevated crude oil prices through 2023. By the way, the RBI in its latest statement has assumed the price of Indian basket of crude oil to be US$90/bbl for FY24, against the current price of US$84.19/bbl (see here).

It is little early to talk about weather conditions in the forthcoming summer and its eventual impact on global food prices. For now, the Rabi crop in India appears to be good; and there is enough food in the Indian granaries. Thus availability of food should not be a problem for sure even if we had a poor monsoon year after three normal/excess monsoons.

Some notes on the current state of the Indian economy.

Monsoon ‘abnormal’ so far

The monsoon season this year has been quite erratic so far. Statistically, during the period from 1^st June to 22^nd August the country has received 9% more than the normal rainfall. However, the temporal and spatial distribution of rainfall has been quite abnormal so far.

·         252 (36%) of the 703 districts in the country have witnessed ‘excess’ (20% to 59% above normal) to ‘large excess’ (60% or more above normal) of rains.

·         236 (34%) districts have received ‘normal’ (upto 19% above or below normal) rains.

·         215 (30%) districts have received ‘deficient’ (60% to 59% below normal) to ‘large deficient’ (more than 60% below normal) rains.

·         More importantly, the granaries of India – UP, Bihar, Jharkhand, West Bengal have been mostly deficient to large deficient. In UP, 66 out of 75 districts have been deficient to large deficient. In Bihar 35 out of 38 districts have received deficient to large deficient rainfall.

The agriculture activities have been affected in large part of the country due to erratic, large excess and deficient rainfall. However, the water storage levels in most reservoirs are now good and soil moisture is also better, which augurs well for the Rabi crop. Thus, despite a below par Kharif crop and poor summer vegetable crop; we may see decent overall agriculture growth in FY23. However, the rural demand in this festival season may be not buoyant. The rural credit may also face renewed stress in some pockets.

Infrastructure orders ‘strong’

NHAI reportedly awarded 6,306km of orders in FY22 – vs 4,788/3,211km in FY21/20, exceeding its target of 5000km. Other government departments and state governments are also accelerating the pace of infra order awarding, especially in roads, irrigation, metro, water and mining. It is expected that the order momentum may sustain in FY23 as well. Reportedly, more than Rs1trn of tenders have been issued in July 2022 alone. Roads, water, and railways continue to be the major contributors for the same.

Among sectors, roads, railways, water and irrigation, and power equipment (Solar EPC) saw strong inflows in April-July 2022. Growth in railways was driven by large wagon orders. Growth in power equipment was driven by solar EPC orders.

Considering the ‘above estimate’ performance of most infrastructure developers, it is evident that the execution may also be improving. It is reasonable to expect that the infrastructure activity may finally be taking off to an acceleration phase.

Inflation expectations ‘anchored’

Reported CPI for July 2022 was at 6.71%, at five month low level. Though, it remained above the RBI upper tolerance band of 6% for 7^th consecutive month. The core inflation-excluding food and fuel segments- came in at 6.04% in July compared to 6.22% in June. Thus a slowdown in inflation rate was primarily driven by food, transportation and communication.

The RBI Governor commented yesterday that “inflation is getting increasingly anchored; has moderated from the peak. Bond yields at the long end are reflecting the anchoring of inflation. Softening of crude and commodity prices is also supportive. Inflation has peaked and is expected to moderate.”

As per the brokerage firm JM Financials, “India’s inflation trajectory is trending downwards while core inflation should be range bound (5.9% - 6.4%) throughout the upcoming festive season before easing meaningfully. But the risk of percolation of high WPI inflation to retail inflation would keep CPI elevated, currently the wedge remains as high as 8.2% and even if July WPI print eases by 50bps, the wedge would still be 8%. Although global supply chains may show early signs of easing, geopolitical issues are far from over and any further escalation would negatively impact crude price and INR. We see Q2FY23 CPI inflation at 6.9% vs RBIs 7.1%, easing inflation would entail a policy action addressing more towards defending
INR than suppressing demand, hence Sep’22 MPC meet should see shallow rate hikes (30bps).”

Borrowing cost and deposit rates rising

As per rating firm CARE Ratings, “Credit offtake had shown an improving trend in the latter half of FY22, which has continued in the first four months of FY23. RBI has been working on reducing the liquidity surplus in the banking system which has been consistently reducing and is currently around the Rs 2 lakh crore mark from Rs 7 lakh crore at the beginning of 2022.”

Weighted average lending rate (WALR) for all banks has risen post RBI hiking the policy rates. Expectations of further policy rate hikes are also prompting certain banks to proactively raise rates. Deposits rates have also witnessed some hikes; though the rise in deposit rates, has been slower than the increase in lending rates.

 The latest macro data indicates that the Indian economy may be standing at an inflection point. It may have survived a major accident in the form of Covid19 pandemic; luckily scraping through with couple of broken bones and some bruises. The economy is recuperating well and is perhaps ready for discharge from the hospital. Of course, for next few quarters the economy may still need to use the crutches of government spending, before it could walk on its own.

The amount of bill for the recovery from pandemic would mostly be known in next six months. We would also know how the cost of pandemic would be shared between various stakeholders, i.e., government, citizens and businesses.

Post pandemic, the challenges before the government are multifold; and so are the opportunities. A successful resolution of these challenges could trigger a virtuous cycle of growth and catapult the economy to the higher orbit. A failure may not be an option, as it could cause a disaster of unfathomable proportion.

The popular words of Jigar Moradabadi may be used to describe the proposition before the Government of India “ये इश्क़ नहीं आसाँ इतना ही समझ लीजे, इक आग का दरिया है और डूब के जाना है”.

1. Broken bones need to be strengthened

The foremost priority of the government should be to strengthen the broken bones (MSME Sector and Unorganized Labor). In fact, these two bones were weakening since demonetization in November 2016. Implementation of GST from July 2017 stressed these further. The pandemic was yet another major blow to these two segments.

Many MSMEs may have lost market share to the larger organized players. The changing consumer behavior in favor of digital platforms also seems to have impacted them. Broken supply chains and tighter credit norms also presented challenges before them.

According to a survey by community platform LocalCircles, “about 59 per cent of the startups and micro, small and medium enterprises (MSMEs) in India are expected to scale down, shut down or sell themselves this year due to the impact of the second wave of Covid-19 pandemic.”

Unorganized labor faced large scale displacement due to the pandemic. Many have since returned to their previous places of work; but the challenges remain. Not all of them have got work due to a variety of reasons. The urban unemployment level remains elevated despite economy opening up materially.

CMIE highlighted that the composition of this fall in employment in August reveals the challenges India faces in providing jobs. The loss was essentially in farm jobs. Non-farm jobs increased to absorb a very large proportion of the jobs shed in the farm sector to leave a net deficit of 1.9 million jobs. However, the non-farm jobs that expanded were mostly not the kind that could be considered good quality jobs.

2. Driver to accelerate growth need to be applied urgently

The drivers for the acceleration of the growth to swiftly recoup the deficit of two years need to be identified and applied. The government has shown intent to turn this crisis into an opportunity by pushing through some key reforms, especially in farm and manufacturing sectors. For example-

·         The government consolidated 44 labour laws into four codes under the Wage Code Bill, Industrial Relations Code 2020, Occupational Safety, Health & Working Conditions Code 2020 and Social Security Code 2020.

·         The three farm laws -- the Farmers' Produce Trade and Commerce (Promotion and Facilitation) Act, the Farmers (Empowerment and Protection) Agreement on Price Assurance and the Farm Services Act and the Essential Commodities (Amendment) Act – have been implemented to allow farmers to sell their farm produce at a price of their own choosing and even outside their respective states, thereby leading to better rural incomes.

·         The production-linked incentive (PLI) scheme rolled out for many sectors, covering a wide gamut of products and technologies, to encourage the domestic manufacturing sector, promote exports and make the country an integral part of the global supply chain.

·         FDI limits increased in key sectors like defense production, insurance, telecom etc.

·         Significant amendments made in Minerals and Mining laws to end monopoly of Coal India.

3. We need to go way beyond mere ‘V’ shape recovery

Merely achieving a full ‘V’ recovery to the pre pandemic level of economic activity will be inadequate, since pre pandemic the economy was slowing for many years and was completely unable to generate adequate jobs for the burgeoning youth population. The government will need to apply multiple accelerators for the sustainable growth to reach to the target of 8% plus.

4. …while preventing a regression to ‘K’ shape

Fourth, the pandemic has widened the divide in the society, as the recovery so far has been rather ‘K’ shaped. Income and wealth inequalities have widened. Disparities in access to digital infrastructure have amplified the divide in social sectors like healthcare and education. The gap between organized and unorganized sectors has enlarged materially. To maintain harmony and peace in the society, these gulfs would need to be managed.

As per a study done by the Azim Premji University scholars, “one year of Covid-19 pandemic has pushed 230 million people into poverty with a 15 per cent increase in poverty rate in rural India and a 20 per cent surge in urban India."

CMIE data showed that “the unemployment rate has gone up as high as 12 per cent in May 2021, 10 million jobs have been lost just on account of the second wave and 97 per cent of the households in the country have experienced declines in incomes”.

As per the study published by Azim Premji Foundation, almost 60% children cannot access online learning opportunities. Reasons for this varied from absence of a smartphone, multiple siblings sharing a smartphone, difficulty in using the Apps for online learning, etc. The issue of access is further exacerbated for children with disabilities. Among teachers of children with disabilities in their regular classes, more than 90% found them unable to participate in online classes.

Of course there is no credible precedent to show that these gulfs could be narrowed materially through state efforts alone. Nonetheless, by building strong bridges (Opportunities and Access) between the two sides which allow the underprivileged to freely and smoothly cross over to the other side, a positive momentum could definitely be created.

5. Need to prepare for short term disruptions that QE unwind might cause

The ultra-loose monetary policies were adopted by the central banks across the world to mitigate the damage caused by the pandemic. These would need to be reversed at some point in time.

 6. Northern borders need to be guarded even more closely

While the world continues to recuperate from the pandemic the geopolitical standoff in Asia is worsening with Afghanistan becoming a symbolic battlefield between US and China (supported by Russia). The worries for India on Northern and North Eastern borders have risen materially with China & Pakistan supported Taliban taking control of Afghanistan, and complete exit of US forces from the region.

7. Erratic Monsoon may spoil the Diwali party

The erratic monsoon and continued supply chain issues mean that the prices of essential commodities (most notably Onion) could rise materially in the forthcoming festival season. As the process of elections in key states of UP & Punjab (and three others) will start around Diwali, keeping food prices under control would be a challenge for the government.

Augmenting supply may not be adequate

The direct measures that the government could take to support the economic recovery are broadly divided in two categories, i.e., (i) the measures to increase the production of goods and services or the supply side measures; and (ii) the measures to support the higher consumption for goods and services or the demand side measures.

The supply side measures usually include direct investment in building enabling infrastructure and augmenting production capacities; or providing incentives to the private sector for investing in capacity building. Some popular supply side measures include building and/or augmenting physical infrastructure and providing investment linked monetary and fiscal incentives, easing production and sales curbs on regulated commodities, relaxing restrictions on import of foreign goods and capital, augmenting money supply and easing credit norms for businesses, etc.

The demand side measures usually include providing monetary and fiscal concessions and incentives to consumers to stimulate demand and increase the utilization of existing capacities. Some popular demand side measures are interest subvention, direct cash benefits, rebate in taxes and levies, subsidizing the retail prices, and relaxing credit norms for consumers, etc.

It is felt that the government strategy to deal with the crisis so far has focused more on supply side measures. The measures to augment demand have been few and inadequate.

The supply side measures that included significant increase in the outlay for infrastructure building, PLI schemes for building capacities to substitute imports and promote exports, aggressive targets for achieving the committed emission norms, credit guarantees, accommodative monetary policy stance etc. These measures are beginning to show some results in terms increased construction activities and higher exports.

The demand side measures included direct cash distribution to farmers and laborers, encashment of LTC, interest subvention on affordable housing, some duty cuts, etc. These measures were materially offset by steep hike in fuel prices, food inflation, wage cuts, higher cost of education and lower rate on savings, etc. Consequently, the household debt has seen sharp rise, private consumption continues to slow down, and unemployment level stays elevated.

Government reluctant to spend

As per CMIE, “GDP data revealed that besides the second wave of Covid-19 deficient government spending constrained India’s economic recovery in the June 2021 quarter from the slump of fiscal 2020-21. Government final consumption expenditure (GFCF) fell year-on-year by 4.8 per cent in real terms during the quarter.

The government expenditure here includes public spending by both, the central and the state government. As per the data released by the Controller Auditor General (GAG), 20 state governments reported a 17.2 per cent increase their expenditure in the June 2021 quarter. But, the central government, on the other hand, kept its expenditure constant at the year-ago level. In real terms, this implies a 4.9 per cent fall in central government expenditure.”

 UBI could be one solution

As highlighted by the World Resource Institute, “About 90% of India’s workforce is informally employed, which includes gig economy workers. This population is extremely vulnerable to economic shocks and needs greater access to formal credit and social safety nets such as insurance and pension schemes.

Beyond employment guarantees, a universal basic income – broader than current schemes that are conditional upon occupation and land ownership – can help provide vital resources for subsistence, or for investing in education and health.”

Household debt needs to be contained

In past couple of months a number of research reports have expressed concerns over the rural demand in the wake intense second wave of pandemic and subsequent lockdown of economic activities. Some consumer facing corporates have also expressed similar sentiment in their interaction with analysts and investors. The popular views seems to be that unlike last summer, when the rural demand remained resilient despite a wider and stringent lockdown, this year the demand may not show similar resilience. Wider and deeper spread of infection this time is one of the primary reasons behind these concerns. Rising stress in household and unorganized sector is also expected the discretionary spending in check.

In this context, there are few points that need to be noted by investors before forming a negative view on consumption theme.

Record production in crop year 2020-2021

Firstly, as per the third advance estimates for the 2020-2021 crop year, the agriculture ministry has expected record foodgrain production for 5^th consecutive year. India's foodgrain production is estimated to rise 2.66 per cent to a new record of 305.43 million tonnes in the current crop year 2020-21, on better output of rice, wheat and pulses amid good monsoon rains last year.

In the non-foodgrain category, the production of oilseeds is estimated at 36.56 million tonnes in 2020-21 as against 33.21 million tonnes in the previous year. Sugarcane production is pegged at 392.79 million tonnes from 370.50 million tonnes in the previous year, while cotton output is expected to be higher at 36.49 million bales (170 kg each) from 36.07 million bales in the previous year.

Given the remunerative pricing and higher volume of crop conventionally augur well for the overall rural income.

Normal monsoon forecast for 2021

The India Meteorological Department (IMD) has forecasted a normal monsoon for 2021. As per IMD’s latest forecast, Southwest monsoon, starting in June, is expected to be normal at 98 per cent of the Long Period Average (LPA).

This week, the widely-respected Australian Bureau of Meteorology (BOM) has also ruled out the likelihood of the rain-disrupting El Nino phenomenon over the next six months. Meteorologists say that a low probability of El Nino is certainly good news for the monsoon, although the complex weather system depends on many other factors.

A good monsoon usually means another year of good bumper farm production and consequent positive impact on the rural economy and consumption demand.

Second wave weakening and economy unlocking

In past one week, the second wave of pandemic has shown a clear tendency to decline. Further improvement is expected over next couple of weeks. It is likely that the mobility restrictions may begin to ease as the Kharif sowing season approaches. It is therefore likely that the income loss and spending curbs (due to mobility restrictions, health concerns, curtailed marriage spending etc.) seen in 1QFY22 may not spill over fully to the next quarter.

Indubitably, full reopening of economy and normalization of household spending may take at least 3 to 4 more quarter, till a significant proportion of the population is inoculated. Consequently, the economic growth for FY22 earlier projected to be in the range of 11-12%, may get constricted to 7-8%. This implies that Indian economy will attain the FY20 level of economic activity only in 2F2022 only.

My personal assessment of the rural and some semi urban areas in UP, MP, Punjab, Haryana, and Chhattisgarh is as follows:

·         Household finances have been damaged across the state, especially in the lower income group families. Lower income and medical expenses have eaten up savings and overall debt level has risen (most of it informal or friendly). The expenses on education and health have risen for a common household. For 5% households these trends may be structural due to loss of life or permanent employment. Lenders (formal or informal) will have to share some burden of this in near term.

·         The consumer confidence for discretionary spending is materially lower. However, two wheeler and smart phone/tablet may not be discretionary in most cases. Clothing, jewellery, home renovation, wedding, etc are some of the discretionary items that may cut material cuts. Down-trading in staples, personal care, shoes, home appliances, personal vehicles is also clearly visible.

·         The credit worthiness of an average household has diminished. The personal loan segment has been witnessing maximum growth in past few years. A slowdown in this segment may be inevitable.

·         The demand for farm input remains robust. Farm credit disbursement however may have slowed. The worst impact is from contraction in farm credit from informal sources. How efficiently this conundrum is resolved, may have material impact on the growth of rural economy. Implementation of farm laws in letter and spirit would be critical in resolving this situation.

·         The loss of life is unfortunate in any case and under any circumstance. In rural area, the Covid fatality rate is materially more in second wave as compared to the first wave. However, given the disguised unemployment and underemployment, the economic impact may not be as severe as many analysts might be anticipating. Not more than 5% households in rural areas have borrowed money to get treated at private facility in towns.

·         Pandemic has actually resulted in upgrade of healthcare facilities in many tier2/3 towns and villages. Hopefully much of this improvement will stay post pandemic also which will be a major positive for rural economy of India.

·         In rural and semi urban areas there is resistance to vaccines. Much of this resistance is result of misleading propaganda by ignorant, mischievous and/or malevolent elements. So far the institutional effort to counter this misinformation campaign in grossly inadequate. Recover would largely depend on how fast we convince people to get vaccinated and actually vaccinate them.

Based on my assessment I would not be too worried about consumer staples beyond couple of quarters. A material correction post 1QFY22 results could actually be a good entry opportunity. I would be extremely cautious about retail lenders, especially unsecured loans, and sale of premium vehicles. Appliances sales may miss this summer season, but might see a near normal festival season post monsoon.