DYNAMICS OF THE INDIAN ECONOMY
Based on interviews with Neelkanth Mishra - Chief Economist Axis Bank, part-time member of Prime Minister's Economic Advisory Council, and part-time Chairman of UIDAI:
India is showing resilient growth despite global headwinds. Compared to most developed economies, we took longer to recover after COVID-19, but we are catching up now, and the world is beginning to slip. The world recovered faster because of considerable fiscal spending, but we were more prudent.
What are the factors that increase productivity and lead to growth?
Labour joining the workforce - 1%
In the 1980s, it amounted to 3% of the GDP, but now, as population growth is slowing down, it amounts to about 1%. This is likely to continue until about 2050 or so when the labour force is expected to peak.
2. Total Factor productivity is growing at 2%
(a) `Labour quality - The education levels are rising. This, too, helps to improve the productivity in the country.
(b) We can assimilate best practices on the services side. Productivity growth in agriculture is minimal because of small farm sizes, etc. Manufacturing is just beginning to start to improve. In services, we have done remarkably well. India's share of services exports is growing faster than the rest of the world. We have a low share in freight, transportation, travel, etc. For anything which does not require a physical presence, we are much ahead of the globe - we have an 8% share.
(c) Modern retail - is also growing faster - e-commerce. We are 4% of the global share, and with our continued growth of 20%, our share has grown exponentially.
(d) We are reimagining infrastructure, which boosts productivity. Railways used to struggle to grow, and capital spent was mostly useless—but now it has taken off. Highways are growing rapidly, and FasTag growth is at 45% CAGR, which also improves our productivity. The number of airports is increasing. Internet usage is widespread.
(e) "Micro Infrastructure" is improving, and this allows for broad-based growth. There is electricity in every village, access to piped water, and widespread cooking gas. This hugely improves the productivity of the women in the villages. As they save time at home, they can spend more time at work.
(f) Tax collection is improving - both directly and indirectly.
3. Capital formation had started falling before COVID and is now rebounding. - 4%
(a) Real estate went into a 10-year downturn. with Demonetization, GST, RERA, etc. Over and above the NBFC financing, the real estate sector was in trouble, culminating in the demise of ILFS – and COVID was the final straw. This was more than a 1% point drag on the GDP for more than a decade. Real Estate is the single biggest purchase for any individual. The house’s value is more than 30 times your basic annual expenditure on food and clothing.
In 2021, the housing inventory started falling rapidly, and it now has about 2 months of stock. This heralded the start of the new real estate cycle. So, whereas real estate sales do not really impact the GDP too much (only brokerage), when the houses are built there is substantial growth in GDP.
(b) Manufacturing capacity utilization is back to pre-COVID levels. As demand picks up, manufacturing units will have to increase capacity.
(c) We overconstructed power plants—even when there was a coal shortage at some point. Hence, no major power plants were built in the last 8 years. However, in October 2023, for the first time in many years, we had a power shortage. Heat waves are back, and so this will continue.
Hence, Real Estate, Infrastructure, and Manufacturing capital formation should add about 4% to the GDP. We have just started this cycle.
Labour growth (1%), Factor Productivity (2%) and Capital formation recovery (4%) - so 7% growth to GDP should be a given - although we need to target higher GDP growth.
All this is happening despite HEADWINDS.
1. Need to reduce government debt to GDP. As demand increases, the Government is indeed cutting their expenditure. Reduction in fiscal deficit is a drag on growth. So, although the government is trying to be more prudent, the government's debt to GDP is expected to remain around this level, so it is not impacting GDP growth.
2. Monetary tightening is also happening. Tighter liquidity implies higher effective interest rates. This slows down credit growth. Whatever economic strength we see is despite the removal of liquidity from the system. For the last 18 months, there has been no money expansion, which translates into banks struggling to get deposits and interest rates remaining firm.
3. Slowing global growth is hurting goods and services exports. And yet India is still doing well.
4. Rising global cost of capital and the fiscal challenge in the US. The debt held by the Public in the US is 100% of the GDP. This is expected to rise to 125% of the GDP in the next 10 years. However, the CBO (their tracking organisation) said that they made a mistake of 3.% +, which will have a multiplier effect over the next 10 years - up to 150% debt to GDP. There is an 8.5% fiscal deficit where unemployment is at 3%. If that increases and/or there is a recession, it can jump easily to 10% of GDP. Even this year, their fiscal deficit has gone up by about 20%, i.e. from 7.5% of GDP to 8.5%. One of the primary reasons for this is that revenues have fallen sharply, which is an indication of a slowdown.
This is not showing up in bond figures yet. The US10-year Gsec spiked to over 5% but came down again to 4.05% and is now at 4.24%. This is because 80% of the bond requirement was met from Treasury bills of less than 1 year. This is not sustainable. Dollar shortages ex-US continue to intensify until the Federal Reserve reverses its stand. Credit growth is slowing down, and yet the economy is growing - and hence, the dollar availability is the worst since 1959. At some time, the Fed will have to do quantitative easing again as a repeat of the 2023 deficit appears difficult to fund.
FORECAST
1. Our Nifty premia over risk-free yields is very low, as the global cost of capital is likely to remain elevated. The net earnings yield vs. the US risk-free yield is at the same level as it was in 2007 - 0.9%. As treasury yields are unlikely to fall, Price/Earnings multiple has to fall. As the world became used to almost zero interest rates, price/earnings multiples rose sharply. Our economy is in much better shape than it was 10 years ago - so from an average 13 PE multiple we can be at a 16 PE multiple - but we are currently about 20 times.
2. Nifty earnings are being projected to grow. Consensus Nifty earnings estimates have been constantly increasing and what is more positive, being revised upwards.
So unlikely to see a sharp drawdown on the Nifty. The market will be driven by Earning growth rather than price-earning expansion. Nifty is currently about 1 standard deviation above its 10 year average and if it stays where it is it will be at the 10 year average next year because of earnings growth.
(a) We can continue to grow at the earnings growth rate. We are unlikely to see any more Price/Earnings expansion - but earning growth of 15-18% can continue.
(b) We can have a time correction so that valuations fall to the average, the Nifty stays at the same level, and earnings continue to grow.
(c) If there is a global negative event, India will also correct it, but with our good Macros, it would be a great opportunity to buy.
EQUITY MARKET
The equity market was volatile this month, especially the mid and small-cap stocks. Continue to look at Large-cap funds as safer options over mid and small-cap - whose valuations are still expensive.
DEBT MARKET
Yields are likely to continue to fall due to:
1. Foreign inflows due to Indian bonds being included in the JP Morgan bond index
2. The government is committed to narrowing the fiscal deficit due to strong tax collection and expenditure rationalisation.
3. The liquidity situation is likely to ease.
4. Core inflation is slowing down.
5. The balance of payment is expected to be positive in 2025.
6. Traditionally, growth slows down during elections.
GOLD MARKET
Gold touched an all-time high in March at over US $ 2200 per troy ounce. This is despite US interest rates inching higher and also with the dollar index again crossing 104. Both these events should have been adverse for gold - but alternatively, it did reach all-time highs.
From February 29th to March 8th, 766 tons of silver were delivered to India. It is understood that Reliance India is building a 20-gigawatt photovoltaic facility and needs silver. Silver could outperform gold this year, as it has underperformed compared to gold, and could catch up.
