Where is the watershed point?

A long-term impact on economy is still not on the horizon. Recently released high frequency data points too are supportive of pessimism rather than optimism, says Dr. Rupa Rege Nitsure.

We are not out of the woods yet. Premature optimism by some of the think-tanks should not lessen the commitment of executive policy actions.

Majority of the global think tanks are upbeat on India and its growth prospects since its new government assumed power amidst great expectations last year. In its recently updated World Economic Outlook (Jul 9), the International Monetary Fund (IMF) says India will be the world’s fastest growing major economy for the second consecutive year in 2016 at 7.5%, even as it lowered its global economic growth forecast.

Paris-based think tank the Organisation for Economic Cooperation and Development (OECD) too said recently (July 8) that India is seeing “stable growth momentum” even as economic activities are expected to slow down in China, the US and many other major economies. International rating agency Moody’s has projected this week (July 13) an increase in demand for steel in India on the back of strong economic growth and revival of infrastructure spending.

Unfortunately, the same optimism is not shared by the local private agencies. Recently released high frequency data points too are supportive of pessimism rather than optimism.

For instance, India’s manufacturing PMI (purchasing mangers’ index) fell significantly to 51.3 in June from 52.6 in May, as order books at factories filled up at the slowest pace since September last year, dampening overall manufacturing activity and putting companies off from hiring staff. Industrial production growth decelerated by 70 bps in May led by a demand slowdown as reflected in the production of capital and consumption goods. The growth in sale of passenger vehicles has started moderating after a speedy start in April and May. In fact, June volume growth for passenger vehicles has been the lowest in the current financial year.

A CMIE study based on 3,000 publically listed manufacturing companies showed an 8.8% contraction in these companies’ net profits in 2014-15 – a fourth year in a row when profits of the manufacturing companies have shrunk. This means in the past four years, the sector has seen 30.0% erosion in net profits. India’s domestic credit rating agency Crisil expects Indian companies’ results for the first quarter of 2015-16 also to disappoint led by soft commodity prices, weak growth in investment-linked sectors, and subdued rural demand.

India’s exports have been consistently contracting since December, 2014 reflecting subdued growth scenario both globally and domestically. Another very powerful indicator of economic activity – non-oil, non-precious metals imports has also contracted in May, 2015 after staying in positive growth zone for around 13 months.

Indian corporates are struggling with low capacity utilisation rates on the back of weak aggregate demand. Weaknesses in aggregate demand are well explained by the core inflation rates (both in CPI and WPI) released in the past two days. Despite, significant increases in petrol and diesel prices in June, the manufacturing companies were not able to pass on the cost increases to consumers due to weaknesses in demand. This is the reason, why despite sharp increases in the prices of food (vegetables, protein rich items, etc) and fuel products, the manufactured product price inflation has fallen significantly in June, 2015.

Non-food credit offtake from Indian banks has been at its decade’s low partly due to weak investment sentiment and partly due to increased risk aversion of banks contributed by very high levels of non-performing loans and restructured assets. Latest data from RBI as well as corporate debt restructuring cell reveals that slippages from restructured assets have been increasing very rapidly. According to the data released by CDR, outstanding cases withdrawn on account of failure have almost doubled in the past one year in value terms to Rs 57,000 crore. There is now a risk that banking sector problems may cause the next slowdown in the economy due to the banks’ reduced capacity to dispense credit. There is no doubt that India’s new government has remained committed to the process of structural reforms as stalled investment projects continue to fall materially across different states and ownership groups. The most recent quarter data show that unstalling activity has primarily happened in the manufacturing, roads and railway sectors. But given the weaknesses in demand and uncertainties surrounding infrastructure availability (esp. power supply), inflation, interest rates, bank finance, etc., no uptick is being seen in new projects or fresh investments. For the first time, in last several years we are seeing good growth in coal production but no commensurate growth in power generation, as demand for coal has fallen on account of industrial slowdown.

At this juncture, a real push has to come from the government capital expenditure. It’s a positive thing that India’s new government has increased spending towards capital expenditure in the first two months of 2015-16 by 32.5% (y-o-y). This has to continue with the same vigour in the coming months also, even if it implies some sacrifice in fiscal consolidation. The fate of large infrastructure projects (including PPP) depends primarily on the government’s funding support and consistent policy framework. Even rating agencies have started looking at these issues more constructively in recent times. For instance, India Ratings in its recent report has said that at the current juncture a marginal fiscal slippage by increasing capital expenditure will not be viewed by it adversely. Another important solution would be to allow rupee to depreciate, as according to Forex experts, the real rupee-dollar exchange rate appreciated further by more than 7.0% during April-May, 2015. This overvaluation of rupee is killing Indian exports amidst the ongoing slowdown in global demand. A push to export competitiveness by allowing rupee’s depreciation in an orderly fashion will go a long way in improving the growth and employment prospects, as most of the exporting industries are labour-intensive. Given the weaknesses in the overall industrial activity, a threat of imported inflation via depreciated currency is not very high in the current circumstances.

Other chronic roadblocks to investment sentiment continue to originate from the issues surrounding affordability of land, rigid labour laws and a complex tax system. Unfortunately, a lack of political consensus has been slowing down the goods & service tax, labour and land acquisition legislations. According to the latest HSBC study on India’s Investment Climate, 58% of the privately owned Indian projects are stalled today because of the policy issues like lack of fuel/raw material supply (20%), lack of environmental clearances (13.1%), land acquisition problem (12.6%), and lack of non-environmental clearances (12.2%).

The problems of the power sector cannot be fixed unless the government fixes the health of State Electricity Boards (SEBs). According to the latest ICRA report, almost 35,000 MW of projects in the Indian power sector have seen cost over-run of 35% due to delays in land acquisition, lack of fuel and other problems. There have been no new long term power purchase agreements (PPAs) between the power generation and state electricity boards (SEB) due to the dismal state of SEBs. This has added to the problems which are already persisting in the power sector.

Problems of public sector banks (PSBs), which still control 72% of the Indian banking sector’s assets cannot be sorted out unless they get top leaders and fresh capital (that can be linked to incremental performance indicators) without any further time loss. A strong revival of India’s public sector units especially in the sectors like banking, power, roads, metals and railways is a necessary precondition to revive private sector investment in the country.

In short, we need to take the rosy reports with a pinch of salt. We are not out of the woods yet. Premature optimism by some of the think-tanks should not lessen the commitment of executive policy actions.

(The writer is Group Chief Economist, L&T Finance Holdings)

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