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India Strategy; What's moving on the ground, Jan19: Benefits to accrue from sharp turnaround in external macro environment

The Indian economy is in a sweet spot on external front as a) brent crude prices have fallen ~35% from recent peak and b) rupee has appreciated by 6% from recent lows - which has led to reversal in foreign flow sentiment for Indian markets (from negative to positive). Current external environment bodes well for current account balance (foreign trade and flows), fiscal deficit, inflation and interest rates. Though global growth concerns would be negative for Indian exports, we expect current global environment to have an overall net positive impact on India’s growth (as India is a net importer of commodities). We also expect lower crude to support demand revival, by adding to disposable income (as per NSSO’s 68th survey ~12% of average Indian’s wallet spend directly depends on crude while rest 88% is impacted indirectly) and enhancing India Inc’s margins (by reduction in fuel, material and freight cost), though after a quarter’s lag (Q4FY19 end/start of Q1FY20E). The liquidity situation at NBFCs too should improve, as RBI has taken measures to ease the situation, such as a) Banks’ outstanding (o/s) credit to NBFCs was up 57% yoy in Nov 2018 and b) RBI’s liquidity adjustment facility (LAF) was in the surplus zone for most of Dec 2018. However, not all is hunky dory as: a) the fiscal situation remains weak (115% of BE for fiscal deficit already utilized), a mild fiscal slippage cannot be ruled out, b) there is moderation in industry growth, given that GST-related disruption in the base has settled and the festive season was rather lukewarm, c) urban consumption demand too is moderating, as 7^th Central Pay Commission (CPC) benefits settle into the base. In this note, we highlight five emerging key trends (inching close to private capex revival, consumption dichotomy, strength in electricity and coal, lower crude and liquidity situation) and how to play them.

Sharp turnaround in external macro environment; domestic growth moderates: A sharp turnaround is seen in India’s external situation (lower crude, rupee appreciation), bodes well for India’s a) current account balance, b) fiscal deficit, c) flows to Indian markets, d) consumer’s disposable income (as petrol, diesel and other related prices come down, albeit with a lag) and e) India Inc’s profit margin. However, the domestic demand environment on the other hand, has seen moderation with the settling of GST implementation-related low base and growth having resumed a normal course. To our dismay, festive season sales have been lukewarm at best with poor indirect tax collection (FYTD19 collections have been flat). If the global environment stabilizes around current levels, we expect benefits to the domestic economy to accrue by the end of Q4FY19E/start of Q1FY20E, thus supporting domestic consumption demand revival.

Fiscal space tight as indirect tax collection and disinvestment receipts lag: FYTD19 (till Nov 2018) fiscal deficit utilization stands at 115% of budgeted estimate (BE) for FY19. Weak fiscal deficit is due to: a) poor indirect tax collections (flat FYTD19) and b) lagged disinvestment receipts (FYTD19 ~20% of BE vs 72% last year, FYTD18). The front loading in expenditure in the early part of the year has abated, with 15% decline observed in overall expenditure in Nov 2018. While we do not rule out a fiscal slippage, the same could be contained at 10bp of GDP (3.4% of GDP against 3.3% budgeted for FY19), as there is a likelihood of the government pushing pending payments to states, Food Council of India, etc. until FY20E (adding to arrears).

Monetary and credit indicators strengthen: RBI has supported the IL&FS scare-led NBFC liquidity crunch by: a) injecting liquidity into LAF for most of Dec 2018, and b) easing norms for bank lending to NBFCs. These measures have led to 57% rise in banks’ o/s credit to NBFCs in Nov 2018. Moreover, ex-NBFC, non-food SCB credit too registered strong 11.4%yoy growth in Nov 2018.

Rural/urban consumption divide stark; rural consumption remains strong but we would monitor Rabi sowing progress: The dichotomy in consumption space continues. Personal 4W sales were weak, perhaps due to fading 7th CPC benefits, interest rate rise in 2018 and higher crude prices (scaled back since Nov 2018). We expect moderation to continue until mid-2019. However, our rural scorecard looks robust, having derived benefits from a reasonable kharif crop, increase in agri and allied activities loan growth, reasonable 3mma tractor sales on a high base; overall, rural consumption demand growth has outpaced urban. We see weak rabi crop as a key challenge to rural consumption, as rabi sowing as of Dec end was down 3% yoy. As 90% of rabi sowing is done by Jan end, we would closely track its development.

Private capex revival likely: Capacity utilisation uptick and capital availability are the key levers for private capex revival. With capacity utilisation in Sep 2018 at 76.1% 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 private capex revival. However, it may take a few quarters for the cycle to take shape, as GNPAs are still high on an absolute basis. Nonetheless, the cycle seems to be inching closer and we would keenly watch for developments on this front.