Understanding the current macro economic scenario - (Part I)

The government had recently released the Q1 performance of the Indian economy. This paper gives an overview of the macro-economic situation.

Is the Indian economy de-coupled?

Not until the financial crises of 2007 was it perceived, that the Indian economy was decoupled from the external market shocks. It was believed that the Indian economy was inherently so strong that a burgeoning middle class and a strong consumption driven domestic market would cushion the economy against any external volatility.

The scenario today has changed though; we are equally dependent on the external market as much as the internal. Oil prices fluctuations, currency volatility, FDI irregularity, all affect our economy today.

This is reflected in the changing structure of our GDP where services now hold a larger stake in the pie than the erstwhile agriculture. Where India still needs a push – investments by both the public and private sector – is the industry (manufacturing) sector.  

GDP growth:

The GDP in India expanded 7.1% in the first quarter of 2015 over the same quarter of the previous year, slowing from a 7.4% growth in the previous quarter and below market expectations. While services and manufacturing grew at a slower pace; mining and construction accelerated and agriculture reported expansion – While not much traction is seen on the ground, these sectors picked up owing to a lower base.

The core sector index that measures the output of 8 infrastructure industries grew by 1.1% reiterating the challenge the government is facing is turning around the investment cycle. The Gross Fixed Capital Formation (Investment Rate) in the economy has de-grown at 27.8% in current terms, as against the corresponding rates of 29.2% in Q1 of 2014-15.

Inflation:

Given the negative growth in (WPI) inflation over the past two quarters, the industry is expecting the RBI to reduce the policy rates.

It remains to be seen whether the central bank bows down to the industry pressure, or still continues to hold the interest rates steady given the volatile global macros – China’s slowdown, Yuan devaluation and the indecisiveness of the Fed’s monetary policy decision.

Many economists are now worrying that the country may enter into a deflationary cycle and with low interest rates, private sector might even more postpone investments.  The threat of India entering into a slowdown phase as that of China is still unreasonable, as 

• India still has a lot of capacity under-utilisation as compared with China 
•  Rupee is free floating as compared to Yuan – India does not face the impossible trinity challenge (the currency is free floating, the capital account is partially convertible and the monetary policy is independent of the government)

The WPI v/s CPI debate:

In a recent interview, the RBI governor mentioned that India today is moving away from tracking inflation based on WPI index to the CPI index – given the broader basket of commodities in CPI. Thus the wait for the interest rates decline continues as although the WPI inflation is in the negative today, we still have not reached the inflation threshold for CPI (3.5%). CPI inflation today is at 5.4% for June 2015.

Given this background the central bank therefore might continue to hold on to the policy rate reduction.

What needs to be done:

The onus now falls on the government to quickly improve the situation on the ground. Clearing policy log jams and political gridlocks over important policies such as Land Acquisition Bill, GST, among others is very important.

The industry is waiting to see action from the Governments side on:

•  Clearing off policy logjams – Land acquisition bill, GST and
•  Increasing investments in infrastructure sector and encouraging private investments – through PPPs
•  Considering FDI in key sectors
• Reducing the cost of capital – HDFC bank recently reduced its home loan rates to 9.25% in anticipation of a policy rate reduction from the central bank

Outlook:

Yet expecting India to overtake China in growth terms in the near future is being too optimistic. We still have a long way to go in terms of policies and ground level infrastructure investments. The long term outlook seems fairly positive given the socio-economic-political environment across the world:

• India is consciously trying to improve its economic ties (trade) and its political ties with its neighbours – Myanmar, Bangladesh, China, Nepal, Pakistan and Sri Lanka. The various state visits by the PM in the recent past have been a testimony to this
•  With the cost of the oil imports bill declining the current account deficit is manageable
•  The rupee has depreciated against the dollar and is expected to remain in the range of 65 – 67 against the USD in the coming quarter (based on an ARIMA forecast model)

Summary:

This is a period of wait and watch on both the domestic and the international fronts. RBI’s decision on the interest rates will be revealed in its monetary policy announcement at the end of this month. The trickledown effect of the rate cuts will be a lagged one.

Some green shoots on the international front include the Dubai Expo 2020 and the Qatar FIFA World Cup 2022. Both these events will open up opportunities for Voltas in the space of HVAC and MEP.

The bigger picture that needs attention is:

• A continued slowdown in the Chinese economy
• The loosening of the Chinese monetary policy 
• The delay in Federal interest rate hike and
•  Macro economic situation in Euro Zone