Growth picks up, but concerns remain

The economy seems to have recovered from the impact of GST and demonetisation and should grow at around 7.5 per cent for FY19

Indian investors ignored the threat of escalation in the trade war as they pushed indices to new highs. There’s been no headway in US-China talks and the US may impose punitive tariffs on an additional $200 bn of Chinese exports. China will retaliate. The beleaguered Trump administration is also threatening to scrap NAFTA as it tries to renegotiate trade terms with Canada and Mexico. This would mean an increase in global inflation and a downtrend in trading activity. While metals may soften on lower demand, crude prices will stay high as Iran sanctions bite and Venezuela collapses.
 
The rupee hit new lows and it is very likely to travel lower. The crash of Argentina’s peso and the weak Turkish lira will mean poor sentiment for other emerging market currencies. The Indian crude import basket is trending at just under $75 per barrel and this means a higher current account deficit for sure.
 
Traders took heart from GDP numbers. GDP grew at 8.2 per cent year-on-year (YoY) in April-June 2018 (Q1, 2018-19) compared to April-June 2017. This beat consensus expectations. There is a pronounced base effect, due to GST launch and the continued ill-effects of demonetisation in the first half of 2017-18. That will continue through Q2 (July-September 2018).
 
Growth was widespread. Manufacturing was up by 13.5 per cent YoY compared to a drop of 1.8 per cent in April-June 2017. Agriculture registered 5.3 per cent growth. Services grew at 7.3 per cent. Private consumption expenditure grew at 8.6 per cent. The economy may, therefore, have recovered from the impact of GST and demonetisation and should grow at around 7.5 per cent for FY 2018-19.
 
Worries about an unsustainable base effect remain. The private investment cycle doesn’t seem to have kicked back into action yet. There were some warning signs about private consumption, given muted automobile sales in August even if allowances are made for heavy rains. Given GST, however, we’ll probably need to club several months worth of data to extract meaningful trends.
 
The Reserve Bank of India’s annual report (2017-18) provides details about the impact of demonetisation after a Parliamentary Committee criticised that lunacy in no uncertain terms. About 99.3 per cent of the money came back. Cash with the public is now back to pre-demonetisation levels.
 
Household savings have increased but so have household borrowings. The savings pattern has changed for the worse with more cash hoarded. In FY18, household savings rose to over 11.1 per cent of the gross national disposable income (GNDI) but financial liabilities have also risen to a seven-year high of 4 per cent of GNDI, from 2.4 per cent in 2016-17.
 
The debt is due to growth in housing and personal loans, including credit card debt, which now total to 25 per cent of outstanding non-food credit. Industrial borrowing has dropped to 35.1 per cent of non-food credit by March 2018, from a high of 44 per cent in March 2015 — a sign of so-so private investment. Credit card loans have more than doubled, to Rs 690 bn (March 2018). Of course, this does indicate private consumption is strong and backs up the GDP numbers.
 
There could be more trouble in store for the power sector. The Allahabad High Court refused to give relief to some 60 companies that owe over Rs 1.2 trillion. The RBI could start insolvency proceedings in 15 days if nothing works out. Lenders may have to accept haircuts of 40-50 per cent in resolutions.
 

Speaking of power, the Anil Dhirubhai Ambani Group’s RInfra was bailed out by Adani Transmission, which bought Mumbai power distribution assets of RInfra, for Rs 188 bn. This reduces RInfra’s debt to Rs 75 bn from about Rs 220 bn and allows RInfra to pay off debenture-holders on a bond where it had recently defaulted. Anil Ambani says he hopes that RInfra could become zero-debt.
 
The India Post Payments Bank (IPPB) has launched services. The network of 155,000 post offices and the base of 170 million post office savings accounts should improve rural access to banking services. That might help to push rural and semi-urban consumption assuming that the kharif crop is okay.
 
Looking at corporate earnings, Q1 was good and Q2 should also be good due to base effects, if nothing else. There will be a drop YoY in Q3 as the base effects wear off. It’s hard to adjust for a tectonic shift like GST but GST collections themselves do suggest a recovering economy.
 
Looking at the broader picture, growth will be reasonable if, and this is a very big if, global events do not derail things. We need to worry about higher crude prices, tighter money supply and deterioration in the trade environment.
 
In terms of PE ratios, valuations across the market are at historic highs. It would be hard to justify these, even if there is extraordinary growth across all sectors. At the moment, the FPIs are positive. Domestic institutions will continue buying so long as the mutual fund SIPs keep coming in. Technically, the Nifty/Sensex are in new zones. So target-setting is impossible and momentum favours the bulls.