Credit Suisse analysed the outlook of for India in a detailed reported titled India Market Strategy – 2020 Outlook.
According to the report, the economic slowdown may continue to worsen. The sharp slowdown in economic growth has been led by industry, exacerbated by de-stocking. While inventory adjustments end naturally, we still see pro-cyclical forces in credit (2-decade lows in nominal GDP growth could drive further tightening of credit conditions), fiscal (both state and central governments cutting spending, or a hike in GST) and sentiment (GFCF growth slowing; consumer sentiment weakest this decade). The rise in bond yields after MPC’s recent pause, the mergers of large PSU banks, and decisions by some state governments to reopen contracts awarded by their predecessor governments are also risks.
Below are four pointers that have been reproduced from that report.
The economic slowdown may continue to worsen.
The sharp slowdown in economic growth has been led by industry, which has driven nearly 2/3rd of drop in growth over the last six quarters. In our view, this has been exacerbated by destocking due to monetary tightness; double-digit decline in power demand in Oct/Nov was likely due to cuts in production to respond to excess inventory at the end of the holiday season.
Inventory adjustments end naturally, but we still see pro-cyclical factors at play that can continue to depress growth:
- 2-decade lows in nominal GDP growth should drive across-the-board re-assessment of loan viability, further slowing loan growth;
- Fiscal stress at state and central governments may force a spending slowdown, and if not, the hikes in GST rates currently being considered would play that role;
- Investment and Consumption sentiments are weak.
Worsening the structural constraint on financial system capacity are the mergers of large PSU banks, the increase in interest rates that the MPC’s unexpected pause in rate cuts has triggered in the bond markets, continued sluggish rate transmission, and decisions by some state governments to re-open contracts awarded by their predecessor governments.
De-stocking is coming to an end.
Growth has slowed precipitously in the last 6 quarters. The slowdown is clearly visible in industry with all of manufacturing, mining and construction slowing, and lately even utilities seeing a sharp correction. Nearly 64% of the growth slowdown is driven by industry, driven primarily by manufacturing.
We continue to believe that a significant part of the growth slowdown was de-stocking led, with the most striking example in the automotive sector, where the decline in sales into the channel was far in excess of the decline in final consumption. While falling growth expectations definitely have a role to play, and in the case of autos so did the upcoming technology transition, a sharp decline in credit availability played a role as well.
The precipitous decline in power demand in October and November was likely exacerbated by industries cutting production to de-stock, and should stabilise. If not, the second-order effects of this decline like in weak rail freight growth could persist, with an impact on truck operators, as well as the health of state distribution companies as their highest paying customers struggle, and demand from lower paying ones stays stable.
Pro-cyclical factors still a risk.
However, stabilisation outside of personal vehicles could be some time away, as lower sales elevate the inventory/sales ratio despite lower inventories. Further, a number of procyclical forces prolong if not accentuate the slowdown.
The first of these is the financial system, where weak nominal GDP growth can and should drive an across-the-board reassessment of loan viability. Slowing credit from private banks who can lend is a sign of this tendency: it is as expected at this phase of the cycle, but can worsen growth further.
- The second force is fiscal.
So far the central government’s spending growth has been elevated, but given the fiscal challenges, it is likely to slow sharply in the second half of the financial year. A potentially bigger but harder-to-track problem is with state governments, which are also badly affected by the slowdown in taxes, and may see just 7% growth in spending, with a drop in spending to GDP ratio as against a budgeted increase.
- The third force is sentiment for investment and consumption.
As seen in the September 2019 quarter, the weakest growth was in gross fixed capital formation (GFCF), which measures investment. Private capex is likely to be pulled in further, as growth estimates get revised down steadily while consensus GDP estimates do not directly impact investment intentions, the cuts being much steeper than in prior years are not likely to be encouraging new projects.
Similarly, India’s consumer confidence index has weakened: the current situation index is the worst we have seen, and the future expectation index is also the worst since 2013. Consumption of even consumer staples has started to slow, indicating that household incomes are now so deeply stressed that growth of even essential items is curtailed.
Financial system capacity and rates remain headwinds.
For the economy to recover sustainably to a 7%-plus growth level, several important changes are necessary. For one, the 15% system credit growth that is necessary to fuel 11-12% annual growth in nominal GDP may be difficult for the current financial system. Even if private banks were to continue growing at 20% a year, and NBFCs and the bond market resume 15% growth, given that PSU banks are likely to continue struggling to grow, there could be a large Rs 20 trillion shortfall in credit availability at the end of five years. India’s private credit-to-GDP ratio is among the lowest in the world.
While financial system capacity remains a concern over the medium term, in the near-term there are serious concerns about credit availability, with major PSU banks in the midst of mergers, and the RBI struggling to ensure rate transmission. Even before it surprised the market negatively by keeping the repo rate unchanged in early December 2019, an action that moved the bond yields up 25 bp, the gap between the repo rate and the weighted average lending rate on outstanding loans was at a record high, near crisis levels. High interest rates when nominal GDP growth has slowed sharply, are a deterrent to credit creation, and will continue to be a headwind to growth.
