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Sourajit Aiyer - Finance Monthly Magazine, UK - Catching Up On The India Story - July 2013


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Sourajit Aiyer - Finance Monthly Magazine, UK - Catching Up On The India Story - July 2013

  1. 1. Special Feature 16 The Indian economy has seen its share of pressure during the last year or so, as headwinds which impacted in FY 2012 (Apr 2011-Mar 2012), continued to pose a downside risk in FY 2013 and FY 2014 till date. Reviving the growth rate is a major challenge confronting policy makers as GDP growth, which hovered around the 7-9% mark per annum in recent years, fell below ~6.5% in FY 2012 and is ~5% in FY 2013 - the lowest in the decade. Widening current account deficit, inflation, manufacturing and services slowdown, fiscal pressures, policy slowdown and the pressure on the Indian Rupee (INR) are major concerns. However, returning to historical growth rates is imperative for a country of this magnitude. Amongst all the negative news-flow, there were few positive ones as well, especially in the second half of the year. Easing in manufacturing inflation/WPI, some action on the reforms front, as well as regulatory changes to increase savings flows triggered short bursts of optimism. EConomIC PErSPECtIvES By Sourajit Aiyer Catching up on the India Story
  2. 2. Economic Perspectives: India licing into GDP segments, agriculture GDP growth was impacted in FY 2013 mainly due to less than normal monsoon rains. The overall slowdown in the industrial output hit manufacturing GDP growth. India story’s biggest driver and the largest piece of its GDP – the Services sector, also saw moderation. This segment has been one of the major contributors to the overall slowdown in GDP, of late. Services segment growth was largely impacted by the trade, hotel, transport sector (comprises almost half of Services pie), as these activities are linked to the first two segments, viz industrial and agriculture. Inflation has been a pain in recent months, owing to price trends in global crude, precious metals, commodities, electricity tariff hikes, supply side inefficiencies, changes in the diet towards protein and better cereal variants, revision of agriculture product MSPs (minimum support price). WPI (Wholesale price index) was over ~ 7-8% through most of FY 2013 as fuel and commodity prices exerted pressure. CPI (Consumer price index) was above ~9-10% throughout the last fiscal. This was largely on account of the higher weightage of food within CPI, which was impacted due to weak monsoons, supply-side constraints, higher MSP and input costs. India’s central bank, Reserve Bank of India (RBI) maintained an anti-inflation stance in the growth-vs.-inflation dilemma. Nevertheless, a reduction in WPI from March 2013 onwards to ~5% due to easing in the global commodity prices has been a positive development. CPI also saw a moderation to ~10% mark, from the 11% plus figures it had notched between Dec 2012 and Mar 2013. These developments in inflation trends ushered in hopes of interest rate cuts, which would eventually revive investment cycles and growth rates. RBI reduced the key policy rates (repo rate and reverse repo rates) in its policy review meetings in Jan, Mar and May 2013. But the country faces two challenges at this juncture. The depreciating INR has exerted current account deficit pressures in recent months. This brings the spotlight back on the growth-vs.-inflation dilemma, with expectations that RBI may hold back any further interest rate cuts till the currency situation eases slightly. This continues to impact growth expectations. Secondly, the rate cuts that were done have not really transmitted into a commensurate reduction in lending rates so far, as liquidity remained tight. India’s current account troubles owing to the balance of payments situation have not boosted its forex reserves, which has also impacted its ability to infuse liquidity. Base rates of major commercial banks have hardly reduced commensurate with the central bank’s rate cuts. Coming to reforms, the need to balance coalition politics took its toll on the speed of reforms’ execution. Environment clearance issues, regulatory delays, inflation and the global slowdown contributed to the slowdown in the investment cycle by companies. High cost of borrowing remained a deterrent, as have the increased focus of banks on the NPA (net performing assets) aspect. Infrastructure development was slow due to regulatory delays, challenges of PPP models (Public-Private Partnership) and long-term funding sources. New projects slowed down and a number of existing projects are currently stalled facing delays. Industrial output remained subdued for most part in recent months, as output in segments like mining, coal, fertilizers and natural gas faltered. This consequently impacted demand for capital goods, commercial vehicles, equipments etc. Nevertheless, initiation of some reforms since Sept 2012, even at the risk of snapping ties with coalition partners, did raise some cheer. The government also set up a Cabinet Committee of Investment as a single window to clear large projects, and is further working towards public spending projects. As inflation stability sustains and liquidity improves, it can lead to further monetary easing and eventually help to lower the cost of borrowing and revive the investment cycle. However, reviving the investment cycle would also demand sustenance of the reforms engine, a more involved decision-making with state governments on issues related to land, resources and closer monitoring of stalled projects to catalyse further investments. On the current account/balance of payments front, India’s growing integration with the global economy meant that continued global economic weaknesses impacted demand for its exports. This is more so given that its major export markets are US and Europe which have undergone their own share of woes in recent years. The import bill was impacted due to price and demand trends in oil, gold, coal, etc. Oil imports are ~80% of total oil demand. Apart from consumption of gold, the demand for gold also shot up due to its perception as a relatively better investment. The trade deficit is now about 10% of nominal GDP now, and the forex reserves have stagnated around the USD290bn mark in recent months. Current account deficit as a percent of GDP increased from a historic average of ~1-2% to over 4%. On top of this, the S
  3. 3. depreciation in the Indian Rupee is hanging like a Sword of Damocles, impacting the current account situation. INR depreciation impacts the import prices of key commodities and negates the positive impact that any easing in global commodity prices could have brought about. Prices of products using such imported inputs also come under pressure. It also exerts fiscal pressure if the entire price rise cannot be passed to the consumers, especially in fuel products. Companies who borrowed via ECB route (external commercial borrowings) face profitability pressures. Nevertheless, the government is working on regulations to curb gold imports and address the needs for domestic oil & gas upstream activities. India is a global production hub for automobiles, consumer non-durables etc. The country also needs to improve the relative competitiveness of exports and expand into new export geographies outside its traditional export markets, especially targeting the frontier markets. The government has been actively trying for trade-agreements with a number of geographies. India has a competitive edge in knowledge sectors like pharmaceuticals, healthcare, IT/ITES, automobiles and ancillary owing to its large talent base in these disciplines. The country may also need to fast attempt some import substitution by way of domestic production, to reduce the import bill to some extent. Continuing on the currency conundrum, from a historical average of ~Rs 45 in the last decade, the INR/US$ exchange rate breached the Rs 50 mark in FY 2012, the Rs 55 mark in FY 2013, and the Rs 60 mark during YTD FY 2014. Action on the reforms front in Sept-Oct 2012 had improved sentiments and the INR appreciated to ~Rs 53. But it subsequently moved back below ~Rs 55 and towards ~Rs 60 as the current account deficit continued to exert pressure. During the fiscal year FY 2013, the INR depreciated against currencies like Chinese Yuan, Thai Baht, Korean Won and Malaysian Ringgit, apart from USD and Euro. Exports have been a key growth driver in most of these Asian peers, and the current currency trends may increase India’s relative export competitiveness. Any uptick in manufacturing sector exports specifically would benefit from the current trends in the INR. On the other hand, the INR appreciated or remained flat this year against other emerging market peers like Brazilian Real, Russian Rouble, as well as the Pound Sterling and the Japanese Yen. Apart from stability in prices of import goods, another possible catalyst for INR appreciation would be to increase foreign direct investment (FDI), as it is a more stable and long-term source of foreign capital. Capital inflows from foreign portfolio investors (FII in Indian parlance) have given some cushion. FII inflows into Indian equities have been robust during most recent months, especially during the months which saw some reforms action. FIIs now comprise the second largest chunk of shareholders in Indian companies after the promoters, holding about ~20% of market capitalization and over ~40% of free-float market capitalization. However, these flows are inherently volatile. Recent news flow relating to USA possibly pulling back on its quantitative easing programme had an effect of pull-out of FII money, although this was mainly from Indian debt. A fall-out of the depreciating INR on foreign investors which might pinch currently is that it impacts the investment returns earned post conversion. In terms of the fiscal situation, the government announced in its recent Budget, as well as in various roadshows, to rein in fiscal deficit to ~sub-5% in the coming year. There has been some reforms action since Sept 2012. The cap on LPG subsidies and the deregulation of diesel prices should ease the subsidy burden to some extent. Tax earnings might be impacted on lower excise earnings, corporate taxes etc as corporate demand and earnings remain muted. However, the net tax-GDP ratio should typically move towards historical averages as the GDP growth shows signs of recovery. While the recent Union Budget kept the tax structure as largely unchanged (except for a couple of surcharges on corporate and wealthy taxes), the government is also expected to earn from non-tax sources. These include its disinvestment programme, sale of spectrum and other resources like mines, land etc, as well as possible cash dividends from the Tax earnings might be impacted on lower excise earnings, corporate taxes etc as corporate demand and earnings remain muted. However, the net tax-GDP ratio should typically move towards historical averages as the GDP growth shows signs of recovery. Special Feature 18
  4. 4. cash-rich government-owned companies (PSUs). It has already approved disinvestment of four PSUs and strategic sale in a couple of firms. However, initial estimates of earnings from disinvestment might seem over-ambitious given the muted investor participation levels in the markets, hence updates in this segment will be closely watched. Opening up of FDI avenues should bring in further long-term capital. Recent announcements included liberalizing FDI norms in sectors like retail, aviation and broadcasting, as well as proposals in pension and insurance. FDI inflow would go a long way in addressing the capital shortfall in meeting deficit targets. On the expenditure side, the Budget also announced a hefty 29% rise in planned spending, given the need to spur growth in the context of the current slowdown. However, the challenge will be to meet the estimated revenue targets from tax earnings and disinvestment and spectrum sales. In the event of lower than expected revenues, expenditures may need to be appropriately managed to help keep fiscal deficit within comfort limits. India has traditionally been a savings-oriented country. However, gross domestic savings as a percent of GDP has declined from the last five-year historical average of ~33-34% to ~31% in the last couple of fiscal years. The country needs to shift from consumption to savings and investment. Within households, the share of financial savings has declined in recent years while that of physical savings has risen, coinciding with the increased demand for gold and real estate which are increasingly viewed as safe-havens by Indian households vis. a vis. Financial saving options. In order to spur retail inflows into financial savings, the government has engaged with asset management companies by initiating several measures like Rajiv Gandhi Equity Savings Scheme to bring in new equity investors, direct mutual fund plans to reduce fund costs, reviving distributor interest through incentives, expansion into small towns by increasing fund expense, flexibility in fund charges, investor awareness initiatives, amongst others. Institutionalization of retail savings has been a key mobilizer towards investment flows, as seen in mature markets like USA, Korea etc. These regulatory initiatives, along with possible growth in disposable income should encourage flows into financial assets further. Apart from India’s strength in its demographic size and structure, a major aspect that needs special mention here is the criticality to build skilled workforce. India has the advantage of having a established knowledge-oriented talent pool which is well recognized globally. Apart from leveraging on its existing talent, the need is also to ensure a supply in the years to come. Skilling of the population is necessary to move up the work value-chain and move up to higher income levels that the population aspires for. In fact, it’s an opportunity the country needs to pounce on, as it would also go a long way in enhancing the competitive edge of the country as a preferred base of operations by global corporations ahead of other emerging market peers. In conclusion, very few countries match up to the demographic magnitude that India offers, and the size of this market would be tough to find elsewhere. Its short term woes do not diminish the long term opportunity that the country offers. Its demographic is still hungry for new, innovative products that give an opportunity for an enhanced lifestyle. From the economy’s perspective, it has faced tough economic times before and has always managed to navigate itself and emerge stronger. Even in the years immediately following the global financial crises, India showed resilience by clocking ~9% per annum growth in GDP in both FY 2010 and 2011. While the recent reforms initiatives boosted sentiments, it is also imperative to address regulatory delays, governance of projects and inflation. The recent interest rate cuts have not really led to a reduction in lending rates so far, as liquidity was a concern. Despite stability in inflation now, the current account deficit and INR situation has placed watchful eyes on the growth vs. inflation dilemma once again. Going forward, the action plan is essentially on reviving the investment cycle, sustaining reforms action, combating inflation, rein in fiscal and current account deficits, create skilled jobs and enhancing labour productivity, expanding export geographies, attempting import substitution, removing infrastructure bottlenecks and reducing borrowing costs. Sourajit Aiyer is the Senior Manager of Investor Relations at a leading capital markets company based in India. The views expressed in the article are personal. It is meant for information purposes only and does not construe to be an investment advice. It is not intended as a solicitation for the purchase or sale of any financial instrument. Any action taken by you on the basis of the information contained herein is your responsibility alone. We have exercised due diligence in checking the correctness and authenticity of the information contained herein, but do not represent that it is accurate or complete. The readers should rely on their own investigations. Economic Perspectives: India