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India Strategy; What's moving on the ground, Oct 18: Current festive season demand – key to determine growth trajectory

Indian economy is currently dealing with headwinds on external front (INR depreciation, stronger crude, rising US yields, FII outflows) and a few on domestic front – a) tighter liquidity conditions for select NBFCs, b) fiscal pressure (record fiscal deficit utilization in last few years, weak indirect tax collection), c) moderation in few high frequency indicators (IIP, freight tonnage, PV four wheelers sales, indirect tax collection). The moderation in domestic high frequency indicators can be attributed to base normalization (Q1FY18 was weak owing to GST implementation related disruption) and Kerala flood impact. On the brighter side, we have observed sustained strength in few other indicators (transactions growth, overall credit outstanding, core industries growth, SIP flows). Consequently, in this scenario, demand environment of current ongoing festive season gathers paramount importance and would be key to revisions in growth estimates. With this background in mind, we highlight bright spots in the economy as indicated by our scorecards– a) ongoing strong rural consumption, b) recovery in urban consumption, c) strength in coal volumes, d) overall credit uptick, e) domestic retail flows.

Macroeconomic fundamentals – Domestic stable but external sector worsens: India’s GDP growth saw upward revision in Q1FY19 on the back of better-than-expected GDP growth in last couple of quarters. However, with the base normalizing this quarter, demand in the festive season would be key to estimate revision. We acknowledge the threat arising from rupee depreciation and strong crude, which is already reflecting in a) stronger WPI and pressure on profit margins for India Inc., b) sustained pressure on current account deficit (CAD) and fiscal deficit.

Fiscal indicators under pressure; festival season to chart the course of action: India’s fiscal deficit utilization has been the highest historically (~95% of budgeted estimates until Sep 2018), due to front loading on expenditure (13.5% FYTD growth against 10% budgeted) and weak indirect tax collection (down ~20% yoy in Q2FY19). While the government is sure of achieving its fiscal deficit target and has consequently reduced borrowing target by Rs~700bn, we believe a lot hinges on a) indirect tax collections during the festive season, and b) progress on disinvestment target. Any weakness here could translate into weaker government expenditure in H2FY19 and/or fiscal slippage, which will not be received well by bond markets. 

Overall uptick in credit but tighter liquidity for NBFCs: While overall corporate credit growth (Sep 2018) remained strong on a 6mma basis with 11.5% yoy growth (despite hardening yields), we believe tightening liquidity for weak/poor quality NBFCs would impact credit offtake in certain segments.

Overall weak flows but domestic retail flows a silver lining: Global headwinds (INR depreciation, stronger crude, rising US yields) have led to continuous FII outflows from Indian equities. On the brighter side, SIP flows have been stable with equity MF retail flows too in the positive territory (moderated but positive). Despite mild slowdown, we do not expect any sharp outflows in retail flows. 

Divergent trends emerging in consumption, but unlikely to be worrisome: The consumption space shows an interesting dichotomy, with staples consumption going strong but consumption of personal vehicles taking a hit. Supporting consumption indicators show that the slowdown in vehicles is not worrisome. Overall, while rural consumption indicators continue to be strong, urban too is seeing a recovery.

Industry and trade indicators moderate on base effect but festive demand key to deciding future growth: Key industry and trade indicators have shown signs of moderation (IIP, freight tonnage, export volumes etc), which we believe emerges from base normalization (as GST implementation-related disruption settled by Q2FY19). Moreover, moving averages for key indicators too have managed to remain stable.

Overall weak capex; Mild uptick in capacity utilization and fall in stalled projects are bright spots: IDFC capex scorecard shows sequential weakness, led by lackluster orders awards, new project announcements, implementation and completion of projects. Although capacity utilization levels are better yoy with commercial vehicle volumes reasonable and tender announcements robust, we believe a full-fledged capex recovery is some time away and hinges upon NPA resolution (important for capital availability) and demand (showing slow but steady recovery).