Exports grew 30% in Nov, 12% in Dec and 9% in Jan 2018 – thus bad old days on the external front are finally gone. India will soon be back to 7% or 8% growth. The booming stock market is a reflection on the country’s growth prospects. I don’t really know whether they’re right or wrong and to what extent, but the following are 7 downside risks to India’s growth story.
1. Though bulls have been predictingthat Sensex will cross 40,000, the stock market party is likely to end soon
2017 will be remembered for its stock market rally which is backed primarily by cheap liquidity and not by strong economic fundamentals. However, the party cannot go on as India Inc. struggles for profits and economic growth slows. RBI pruned down its growth forecast to 6.7% in October from 7.3% projected earlier and it has not revised up this number in its latest monetary policy announcements in December. The official Economic Survey has also pruned its growth estimate to 6.5% in FY 2017-18.
The US Fed and China have already started tightening interest rates and other Central bankers in particular ECB, Japan and others will do so sooner. That will reduce the relative interest gap between India and these cheap liquidity supplying countries. That will slow the inflows of foreign money into India and put a check on equity market rally thereby inducing domestic investors to go slow as well on investing in equities and equity mutual funds - that will eventually end the party. It’s a common knowledge that retail investors usually join the party late and when the party ends they pay dearly…if that happens, that will affect households’ savings and consumption.
2. Private sector capex may not pick up anytime soon
Investment, as measured by gross fixed capital formation, grew 4.1% in Q2 (July-Sept 2017) compared to 1.6% in Q1 (April-June 2017) but as a proportion to GDP, it has declined to 26% or so. The private sector capex still doesn’t show any definite sign of revival because of lower capacity utilization at 71% and stronger rupee-induced imports, though recent hikes in import duties may provide temporary relief to selected industries. Hence, many expect the government to make up for the sluggish investment in the private sector. The problem is more than 85% of government budgetary allocation is spent on unproductive revenue account that’s not likely to change anytime soon – certainly not in 2018 and before the general election.
In India, the fiscal multiplier of capital expenditure is 2.5 compared to less than 1 for revenue expenditure that includes spending on salaries and allowances of government officials, food and fuel subsidies, and interest payments. This means that a 1 rupee spending on the creation of capital assets leads to a 2.5 rupee increase in India’s national income, while a 1 rupee spending on revenue account adds less than a 1 rupee to the national income.
The Finance Minister Arun Jaitely’s last budget did increase capital expenditure by 11% but that stood for no more than a 0.5% increase in the share of capital expenditure in total budgeted expenditure. That’s not enough to make up for the decline in private sector investment. To make matters worse, the share of unproductive revenue expenditure has increased and efforts at doing away with the distinction between revenue and capital account expenditure doesn’t exude confidence in the government’s ability to hike capital expenditure.
Unfortunately, in the run-up to the crucial state elections in the current year and general election later in 2019, Modi government will be more populist, and the reforms that India Inc. or foreign investors hoping for are likely to take a back seat in the remaining part of the PM Modi’s current term. Last Union Budget unveiled on Feb 1 was a big disappointment on pushing economic reforms. The FDI inflows remain robust but most of it coming through private equity or M&A route that doesn’t create new assets or jobs.
3. Rising NPAs and sluggish credit growth
The bad loans of India’s banking system including INR1.03 trillion of private banks rose to an INR8.37 trillion as on Sept 30, 2017, despite all the measures to reduce them. Now, India’s major state-owned banks are mired by a series of loan frauds and scams that will absorb most of the recently infused capital through the government’s INR 2.11 trillion recapitalisation program.
The high and rising non-performing loans of banks aided by loan frauds and wilful defaults will reduce their ability and willingness to finance even slightly riskier projects. The subdued demand for bank credit makes it worse. That is likely to prolong the recovery of private investment and will have implications for economic growth going forward.
The credit to the industrial sector grew by just 0.8% (YoY) in November compared to a contraction of 3.4 in Nov 2016 even though the overall non-food credit offtake increased by 8.8% - mainly driven by retail loans. RBI says the loan offtake by small and micro industry rose by 4.6%t (YoY) in November 2017 compared to a decline of 7.7% same month last year. Though things were improving on credit growth but these recent loan frauds and bank scams will kill all chances of revival of capex in private sector.
4. The jobless growth menace to continue even in 2018
According to a recent survey by BSE-CMIE, India’s population in the age bracket of 15+ was up from 942 million to 968 million in the year to August 2017. However, in this period, the number of employed increased from 403 million to 405 million. To make it worse, top job-creating sectors such as real estate, information technology, pharmaceutical and textiles are facing numerous regulatory and non-regulatory challenges. Together these important sectors will pull down dependent industries and services and further impede the process of job creation.
Unethical business practices by top companies such as Airtel or ICICI Bank will add to the problem and may invite even more stringent regulations that will limit their growth prospects. Along with the shortage of jobs for graduating youths, top Indian companies are facing difficulties in hiring suitably skilled personnel and many positions remain unfilled. The process of skilling is going nowhere in the country.
5. Slowing agriculture
Despite normal monsoon, agriculture and allied sector grew just 1.7% in Q2. Rural distress caused by demonetization and global supply glut is the latest risk to India’s economic growth. In the run-up to crucial state elections and general election Modi government has tried to appease the rural voters with increased subsidies and dole outs. However, in the absence of tougher structural reforms (that the government has been promising but not following through with genuine implementation), will have limited impact on pushing agricultural growth and improving the lot of the over-crowded farm sector.
6. Slowing consumption
The consumption accounts for roughly three-fifths of India’s GDP but it grew a meagre 6.5% in second quarter of the current financial year compared to 7.9% in the same quarter a year before or 8.4% (YoY) in the first quarter of FY2016-17. The slowing farm sector, subdued private investment and jobless growth along with rising inequality will further dent consumption prospects going forward.
7. Fiscal slippage
India’s fiscal deficit at the end of November overshot the full financial year’s budget estimate for 2017-18 to 112% i.e. INR6.12 trillion against the target of INR5.46 trillion (i.e. 3.2% of the GDP) mainly due to lower revenue collections and higher expenditure according to CAG.
To make it worse, crude oil prices are on the rise, inflation is inching up while tax collection (GST, in particular) remains lower than expected. That may ruin all fiscal calculation. The Finance Ministry says that India’s fiscal deficit will go up only by 30 basis points to 3.5% of the GDP in the current financial year, and at 3.2% of the GDP in next financial. However, the bigger worries are untamed revenue deficit.
8. Sluggish exports
Though merchandise exports grew 30% in Nov it had dropped 1.2% just a month back in October. Similarly exports grew 12.3% in Dec but only 9% in January. Thus, it would be too early to conclude that solid export growth is back. Moreover, India’s merchandize exports are hovering around $300 billion for the last 7 years because of a narrow export basket with focus on low value items such as apparels, footwear and leather goods or other low margins commodities including refined petroleum products and agricultural and food items.