Market sentiment has been moving on a constructive path, even as worries of weak demand conditions and prospect of feeble earing season is underway. The benchmark indices have recovered since mid-September, gaining 9 per cent following several growth-boosting measures announced by the government and the Reserve Bank of India (RBI) in response to decline in real gross domestic product (GDP) growth to 5 per cent in the first quarter of financial year 2019 – 20 (Q1FY20).
The question now is whether the pervasive fear of continued growth slowdown will mar sentiment again?
While it is undeniable that there has been a cyclical deceleration in growth since end of 2018, but what has been adding to the structural headwind is the intensified US-China trade conflict. India has seen a disproportionate impact through multiple spill-over channels like contraction in trade activities, and deflationary impulses seeping into decline in nominal growth, a miss on tax collection, lower spending and resurgence of non-performing assets (NPAs) in the banking sector.
In our view, decline in India’s growth over the past 12 months can be attributable to four factors: 1) the lingering impact of the demonetisation shock and hasty implementation of goods and services tax (GST), which together impact the informal sectors; 2) the spill-over effect of US-China trade conflict; 3) pro-cyclical fiscal tightening; and 4) the ongoing crisis in the non-bank finance companies (NBFCs).
Several of these are structural shock. That said, some of these stress points may be ebbing.
The spill-over of global trade disruptions, which explains over 50 per cent of contraction in consumer durable volume (including major auto sector), is stabilising after the initial shock impact in 2019, and domestic stimuli are expected to pan out. Hence, there is a fair possibility of demand revival in Q3FY20 onwards.
The October 2019 talks between the US and China has thawed the logjam on trade, with both sides appreciating the political and economic damage arising from trade conflicts. Unlike the earlier attempts, the compulsion towards reconciliation is higher. While the US economy is still resilient, latest surveys show declining approval rating of President Donald Trump. US households are unhappy over his handling of the trade conflict. Aggressive hike in tariffs to levels not seen since the Great Recession is seen impacting their livelihood and increasing the risk of a recession in an election year 2020.
On its part, China has been diversifying its sourcing of imports from the US by reducing tariff rates elsewhere. But worries on the economy, rising food inflation and the chance of Trump coming back for a second term is prompting a mellowed Chinese position.
Global trade volume growth has recovered from the initial shock of early 2019 when it contracted by an annual rate of 4-5 per cent; in July 2019 it grew 1.9 per cent month-on-month (MoM) seasonally adjusted, even as it contracted 0.9 per cent from a year ago. Global manufacturing sector PMI for September 2019 at 49.7 is still contracting, but it is an improvement over the previous two months. Hence, dissipation of US-China trade dispute and progress on Brexit can improve global trade activities going forward.
From India’s standpoint, easing of trade disturbance comes along with growth stimulating measures. Importantly, the cumulative 135bp rate reduction by RBI to 5.15 per cent, faster transmission by linking bank lending rate to repo rate, frontloading public sector bank (PSB) recapitalisation, incentives for MSME, exports, real estate and reduction in corporate rate comprise a mix of demand and supply stimulating measures. While the transfer of resources of RBI of Rs 1.75 trillion (including potential interim dividend of Rs 300 billion later in FY20) has enabled revival in government spending in August 2019, we believe the shortfall in tax collection will required higher fiscal deficit of 3.6-3.8 per cent of GDP vs budgeted 3.3 per cent.
Hence, as we see thing panning out in the next four – six months, the revival in growth in India will be led by the unwinding of the stress in the consumption sector. Improvement in rural demand from gains in agriculture sector terms of trade, good monsoon and improvement in government allocation should revive demand for both non-discretionary and stable consumption. However, beyond the unwinding of demand, a sustainable growth recovery can only happen if private capex emerges.
Dhananjay Sinha is head of strategy research at IDFC Securities. Views expressed are his own