BackIndia is on an extremely slow path to economic recovery: Report
The time is running out for lending rate cuts with the April-October busy industrial season barely two months away
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The June quarter real gross domestic product (GDP) growth works out to be around 5%, from 5.2% in March in the old GDP series. Bank of America Merrill Lynch in its report, 7%/ 5% growth: Very very slow recovery on track, said on balance, there is a 30 basis point (bps) downside risk to its 7.5% real GDP growth forecast for financial year 2016 due to poor rains. One basis point is one-hundredth of a percentage point.
In the new series, real GDP growth, at 7%, surprisingly slipped below gross value added (GVA) growth, at 7.1% despite higher net oil taxes. But the nominal GDP growth, at 8.8%, was higher than 7.1% GVA growth in line with expectations. GVA growth, at 7.1%, expectedly improved from 6.1% in March on base effect.
However, lead indicators in the economy point to a very slow recovery. These indicators have signalled since last August that growth is bottoming out, although there has been no discernable improvement since.
Path to recovery
It is lending rate cuts rather than capital expenditure that will drive recovery. Not surprisingly, capital expenditure has actually slipped to 29.4% of GDP in June quarter from 30.3% in March 2015. Although it is conventional wisdom to say that the last cycle was driven by investment, the fact is that this itself was spurred by rate cuts under former Reserve Bank of India (RBI) governor Bimal Jalan.
The time is running out for lending rate cuts with the April-October busy industrial season barely two months away. Although the money market deficit has seasonally come off to reverse repo mode, tight reserve money has pulled down loan growth below 10%, from a medium-term average of 21%, constricting loan supply. In this respect, HDFC Bank Ltd’s 35 bps base rate cut is twice welcome.
Though it is important that lending rate is cut for cyclical recovery, reforms are important, especially from a 5-10-year perspective. There will not be any effect on growth due to the central government withdrawing the land ordinance. It is unlikely that this will pass, unless the Bharatiya Janata Party wins the Bihar polls of October-November. Moreover, a recent Right to Information (RTI) query has revealed that a mere 8% of the projects stalled across India (66 of 804 stalled projects) are due to land acquisition issues. Similarly, the goods and services tax will raise GDP (not growth) by 1-2% over a few years.
As for rate cuts, the central bank should cut rates by 25 bps on 29 September, given the conditions of slow growth and soft inflation.
Consumption recovery
Investors should focus on the impending pick-up in discretionary demand of $100 billion in the next three years rather than a turn in the capital expenditure cycle or reforms (which will take 5 years to support growth).
The drivers for this are banks cutting lending rates; implementation of the 7th Pay Commission, raising central government salaries by 0.3-0.5% of GDP; household savings from lower oil prices reaching a critical mass of about 0.4% of GDP; and rural boost if the government hikes wheat prices by, say, 10%, to implement the Swaminathan formula in early 2016 before the early-2017 Punjab and Uttar Pradesh polls.
Rupee view
The RBI is expected to anchor the rupee at 65 per dollar after allowing for weak seasonality and global uncertainty. The $6.5 billion Iran oil payments—largely off-market—and the $3.5 billion foreign exchange repayments (largely rolled over) should get done smoothly. Foreign portfolio investment (FPI) flows will depend on a few factors—possible passage of GST; $5 billion FPI government securities limit hike; and earnings recovery. RBI can sell about $20 billion to defend 65 per dollar and still maintain the critical 8-month import cover of $315 billion (on March 2016 basis).
Edited excerpts from Bank of America Merrill Lynch’s report, 7%/5% growth: Very very slow recovery on track.
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