Although quick reform may not happen due to the Parliament logjam, the economy is ticking along. A better-than-expected monsoon means a decent harvest and lower food inflation later this year. But corporate results have stagnated and bank credit growth is down
As predicted by sundry political pundits, the monsoon session of Parliament has indeed been a washout.
With a little help from Lalit Modi, the Opposition has rained on Narendra Modi's parade. There has been no discernible movement on the goods and services tax (GST) bill; there has been backtracking on the land acquisition amendment; there has been no further movement on labour reform; the black money law has been criticised. The suspension of 25 Congress MP has triggered a hardening of stances by a more united opposition. This will make it difficult for the government to get the cooperation of the Rajya Sabha in future sessions.
However, even though hopes for quick reform have receded, the economy continues ticking along. While the global slowdown has meant a drastic slowdown in exports, it has also reduced crude prices. Exports have dropped for the past three quarters in a row with seven successive months of falling merchandise exports. Part of the fall in value can be attributed to falling prices of exported petro-products but leather, textiles, gems have also dipped in volume and value.
Nevertheless, the windfall from the reduction in crude prices has brought down inflation and reduced imports, controlling the current account deficit. In addition, the monsoons have been better than initially feared. A decent harvest should reduce food inflation in the second half of the fiscal.
A couple of positives are also visible from corporate results in Q1, 2015-16. Automobile (and auto-ancillary) sales are up and profitability is up considerably. This could be the first sign of consumption rebounding. Housing finance firms have also seen double-digit volume expansion and higher profitability. Again, this may be a sign of returning confidence for the urban middle class.
Bank credit growth is in single digits and at multi-year lows. Public-sector banks (PSB) have taken on enhanced provisioning to write down non-performing assets. The new tranche of Rs 70,000 crore earmarked by the Centre to recapitalise PSBs will be good money thrown after bad, unless the banks are freed from interference and allowed more autonomy.
The Reserve Bank of India (RBI) held status quo in the policy review last Tuesday but RBI Governor Raghuram Rajan hinted that the central bank might be contemplating more cuts in the Repurchase Rate (repo). The January 2016 inflation target is six per cent or less year-on-year change comparing the consumer price index of December 2015 to December 2014.
However, the RBI also wants better transmission of three rate cuts amounting to a total of 0.75 per cent off the repo this year. Banks have not passed those cuts along - since commercial interest rates have dropped by an average of only 0.3 per cent.
Corporates have started seeking alternate financing at lower interest. There have been large expansions in overseas corporate borrowings, and in the issuance of Corporate Paper. The former is exposed to currency risks if unhedged. The latter is unsecured and defaults would leave creditors in the lurch.
The RBI has to factor in the probability of a US Federal Reserve rate hike. The Dow Jones Industrial Average has dropped (by tiny amounts admittedly) for the last seven sessions in succession as anticipation of this has grown. The latest US payroll report seems quite strong, so a Fed fund hike in September looks possible.
If the Fed does not hike in September, it may hike in December. But a hike is very likely in the calendar year. Any hike will strengthen US dollar. At that stage, the RBI will have to take a call. Another apprehension - a rate hike by the Bank of England - now looks unlikely to happen in 2015.
In the meantime, China continues to struggle to stabilise its financial markets. Mainland stock indices are still gyrating wildly. Gold has pushed lower as a result of Chinese selling. Ferrous and non-ferrous metals have also moved lower on fears of slower Chinese growth. This compression is one reason why the Indian auto sector has done well due to falling expenses.
European corporate earnings have been surprisingly good with many companies beating estimates in the April-June quarter. The relatively weak euro has probably helped. But European corporates have used the profits mainly to buy back shares, rather than investing in the real economy.
Technically, the Indian market seems mildly bullish. The Nifty has held its ground above 8,400 and it is now testing resistance above 8,550. Breadth has been positive during the past two weeks. But institutional presence has been thin and net institutional contribution to equity has been very low.
There is a lot of fence-sitting evident with foreign institutions in particular, waiting for more news flow on both the corporate and macroeconomic front. Under the circumstances, attempting to read much into the current sequence of low-volume, low-amplitude movements is not worthwhile.