Photo: Mint
Photo: Mint

‘Whatever it takes’ policy hasn’t stopped the slump

  • Causes of the slump are largely known, but a solution remains a trial-and-error approach
  • Economists blame the cash squeeze in NBFC, which was accompanied by a global demand slowdown

Corporate tax cuts: Done. Re-capitalization of ailing public sector banks: Done. Providing funds to cash-strapped realty sector: Done. Putting money in the hands of rural population: Done. Spree of interest rate cuts by Reserve Bank of India (RBI). Done.

But the flurry of activity to revive the economy isn’t showing results yet. The title of a recent equity strategy report by Jefferies India Pvt. Ltd pithily captures the predicament: Awaiting whatever it takes part deux.

“Credit growth is slowing and tax collections are now falling with power demand down a startling ~11% in October & November. A quick rebound even from the likely sub-5% GDP growth in 2QFY20 seems unlikely, therefore, making more policy impetus necessary even if inflation rose to 16-month highs," analysts at the brokerage said in a 14 November note to clients.

The causes of the slowdown are largely known. But a solution remains a trial-and-error approach.

Economists blame the cash squeeze in non-banking financial companies (NBFC), which was accompanied by a global demand slowdown. Not much can be done about global growth woes. But delayed transmission of interest rates by banks is hampering domestic demand revival, they say.

“The slowdown in demand that we are seeing today is largely an outcome of last year’s liquidity crunch. Hence, to reverse this slowdown, the RBI needs to ease further. So far this year, it has injected $30 billion worth of durable liquidity into the system and we expect (injection of) another $10 billion," Indranil Sen Gupta, India economist, Bank of America Merrill Lynch, said in an interview.

However, for every rupee injected by RBI into the system, it takes about six-nine months to multiply into a credit of 5. Therefore, there will be a long gestation lag before demand comes back, he said.

Despite lower interest rates and surplus liquidity, borrowing cost remains high and credit risk-appetite low, DBS Bank economist Radhika Rao said.

“Sections previously met by non-banks are amongst the worst hit, thereby nullifying some of the benefits from a conducive rates backdrop," she added.

Graphic: Paras Jain/Mint
Graphic: Paras Jain/Mint

Series of recently released high-frequency data continues to mirror the depth of this slowdown. A historic fall in power generation in October only adds to concerns of the manufacturing sector. Little wonder then that economists are penciling in a dismal September quarter gross domestic product (GDP) print, due later this month.

The question remains what more will it take for demand to return? With the Union budget approaching, expectations of reduction in personal income tax cut are rising. “Lower tax outgo leaves room for higher discretionary spending, which will boost demand for white goods, travel, etc., but unlikely to evidently improve for large ticket spending (e.g. real estate)," Rao of DBS added.

Even if the government were to go for further tax cuts, it will come at a cost. Already in a tight spot on the fiscal deficit front, a further compromise may be on the cards if tax reductions were to come.

Economists at State Bank of India Research suggest countering the slowdown by not announcing negative policy surprises for key sectors like telecom, power and NBFCs. If concerns of these sectors are addressed through proper policy measures, then fiscal policy could only act as a supplement, they said.

Meanwhile, India’s deteriorating macros have led several institutions to downgrade the country’s GDP growth forecast. But the Indian equity market remains largely oblivious to this prolonged slowdown. That said, given the expensive valuations, caution is warranted. At a one-year price-to-earnings multiple of 18 times, the MSCI India index is trading much higher than Asian peers.

“India’s equity markets appear sanguine that the worst has passed. For now, earnings remain sluggish with our estimate for market earnings per share down 3% in the last month even though ~60% of our coverage have moved to the lower tax regime with the rest either likely to stick to the current regime or undecided," analysts at Jefferies Ltd said in a report on 14 November.