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India Strategy; What's moving on the ground, Feb 2019: Shift in underlying macroeconomic narrative

India’s underlying macroeconomic narrative has undergone a dramatic shift in last 4-5 months. A couple of quarters ago: a) gross NPAs in the banking system kept surging, b) retail credit was the strongest growth category, c) urban consumption enjoyed sugar high from phased implementation of 7^th CPC (central pay commission), d) globally and domestically, we saw a rate hike cycle, and, e) Oil prices peaked. However, over last 4-5 months, 1) domestic industry growth has moderated, 2) rural consumption has seen impetus from government spend (PM KISAN scheme), with urban stimulus having peaked out, 3) NPAs too have peaked, with banks gradually coming out of Prompt Corrective Action (PCA), causing corporate lending by Indian banks to increase, 4) led by expansionary budget presented on 1^st Feb, we expect to see crowding out in bond markets, thus pushing corporates to borrow more from banks, 5) consistent undershooting in inflation forecast and moderating growth led to RBI changing its stance (from calibrated tightening to neutral) and initiating a rate cut cycle (we could probably see one more 25bp rate cut), and, 6) oil prices albeit volatile, fell into a comfortable zone (unless it crosses US$75/bbl). While headline growth continues to assume a moderate trajectory, the above-mentioned shift in trend warrants attention to time the play well. Given this backdrop, we expect the following themes to play out over the next 3-12 months: i) Strength in rural consumption, ii) steepening G-sec yield curve and wider yield gap for corporate bonds and G-secs, iii) higher corporate lending by banks,  and, iv) a selective revival in private capex.

Fiscal tax collection targets look ambitious and warrant caution: Q4FY19E implied estimates and FY20 budget estimates look ambitious, especially on the tax collection front (GST and income tax collection to GDP ratio is budgeted to increase 20bp each in FY20BE). A failure to meet these estimates would have a direct impact on capital expenditure plans and the fiscal math.

Domestic growth weakens; NPA recovery and improved oil prices to support growth: Driven by weakness in Industry and exports, recent GDP growth expectations have been revised downwards mildly. We expect NPA recovery to support credit, which in turn should support economic recovery. Oil prices have been volatile and are ~23% below the peak (at US$86.3/bbl). We expect oil prices to support growth so long as they remain below US$75/bbl.

India’s fundamentals look strong to weather the storm, even though external segment grapples with uncertainty: US-China trade war has caused global growth to slow down; we sense market volatility as the two countries progress on their negotiations on the trade war. We believe India has strong fundamentals to weather any unexpected storm, given the country’s robust import cover and stable exchange rate.

Steepening yield curve and crowding out of bond markets: Bond markets could get flushed with government securities in FY20E (keeping the long end of the yield curve sticky), considering that RBI has initiated a rate cut cycle, albeit a shallow one (which would put downward pressure on yields, lowering yields on the short end); we expect the pressure on FY20E yield curve to steepen. The state and central governments’ combined borrowing program of ~Rs12.5trn expected in FY20E too would lead to the crowding out in bond markets, leaving little room for private corporate players to borrow.

Rural consumption growth drivers remain strong: We expect robust growth in rural consumption, driven by impetus from PM KISAN and MNREGA (~4.7% of Agri GVA), highest in recent history) and strong FY18 and FY19 kharif output. On the other hand, we expect urban consumption could be weak over the next 2 quarters, as the high base from 7^th CPC’s phased implementation settles down.

Selective revival in private capex: Uptick in capacity utilisation and capital availability are key levers that would aid revival in private capex. With capacity utilisation in Sep 2018 at 75% and GNPA falling 70bp to 10.8% from a peak of 11.5% in Mar 2018, both levers seem to be warming up for a possible revival in private capex. However, slower demand on ground in the near term could be a dampener and it may take a few quarters for the cycle to take shape. Nonetheless, the cycle seems to be inching closer to revival and we expect selective revival in capex in near term.

IDFC top picks: With this note, we are adding NCC to IDFC top picks list. Top pick list: ICICI Bank, Maruti Suzuki, L&T, Asian Paints, GAIL, Hero MotoCorp, Dabur, Aurobindo Pharma, Aarti Industries, KEC International, Indian Energy Exchange (IEX) and NCC.