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India Strategy: Weakness persists, expect fiscal support led recovery inH2FY20

Recently released economic data further corroborates the ongoing weakness in the Indian economy and seems worse than earlier expectations. However, we expect strength in the government expenditure and recently announced corporate tax rate cuts to fuel recovery H2FY20 onwards. We discuss the key data releases below:

5. a) Sep-19 Core industries output declined by 5.2%yoy and it is the weakest yoy output change since series got rebased to 2011-12. The weakness in series can be attributed to overall economic weakness as well as heavier than usual rainfall in 2019 (which typically has adverse impact on mining etc). Looking deeper, 3 year CAGR growth also stands at a mere 1.1%yoy, highlighting a very tepid up-move from dual shock of GST implementation and demonetization. Barring fertilizers none of the components is exhibiting any strength either in Sep-19 or on a moving average basis. In fact, Coal output recorded a 20%yoy decline in output. However, led by fiscal support, we expect a trend reversal here in H2FY20
6. b) Fiscal numbers for Sep-19 show significant step up in government spending, afforded by mainly by non-tax revenue coming from Rs 1.5n transfer of resources from RBI even as tax collections show feeble performance. Total expenditure till now at Rs 15tn (YTD FY20) surged 14.1% YoY, which is a significant rise from 6.5% YTD growth till Jul’19. Total gross tax collection remains anemic at Rs 9.06tn YTD up 1.5%, a decline from 6.6% YTD in Jul’19. Overall 93% of FYTD20 budgeted fiscal deficit has been utilized till Sep-19, primarily led by weak tax collection.
7. c) Sep-19 ex-NBFCs, non-food credit growth stood at 6.4%yoy which is far from a high seen in Nov-18 with 11.4%yoy growth. Moreover, ex-NBFCs services credit declined by 0.4% yoy, for the first time in history. As banks have increasingly supported NBFCs, their lending to real sector has suffered. On the positive side, growth in personal and agri loan o/s series has been most stable

Outlook: As we have held since the announcement of the Union Budget in Jul’19, GoI fiscal policy slant is turning out to be simulative with significant ramp up in spending during Aug-Sep. The performance of tax collection has been unusually weak reflecting weak domestic economy, deflationary pressure and impact of pro-cyclical fiscal contraction in the earlier quarters.

The gambit now appears to improve demand scenario by front-loading of fiscal stimulus (both spending enhancement and corporate tax rate cuts), funded by transfer of resources from the RBI and step up in disinvestments and accepting higher fiscal deficit. Gains in growth momentum can subsequently improve tax collection. If the recent easing of global trade conflicts sustains, it an can also enhance collections. However, we believe there is significant scope for shortfall in tax collection of the order of Rs 2tn given that H1FY20 delivered a modest gross tax collection of 1.5%. Hence, we maintain that fiscal deficit for FY20 will end up closer to 3.6-3.8% of GDP compared to the budget target of 3.3%.

Though overall high frequency growth numbers are turning weaker than earlier expectations, we believe that economic growth would start seeing recovery in H2FY20, particularly led by a) recent fiscal support in form of corporate tax rate cut and increase in government expenditure, b) along with a recovery in global trade.