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Be prepared for a long period of sluggish and below trend growth: Sonal Varma, Nomura

Sonal Varma-Nomura-1200
The risk for India essentially is a fairly prolonged period of bottoming out process. The timelines for the private investment cycle to pick up get pushed out even further, says Sonal Varma, MD and Chief Economist (India and Asia ex-Japan), Nomura. Excerpts from an interview with ETNOW.

You have flagged off numerous macro headwinds facing the India growth story. Over the next couple of years, which of these would you rank as the most significant and why?
The biggest issue for India is really the balance sheet issue because it is not just about the last 12 months of economic slowdown, if you step back for the last five to 10 years, private investments have been extremely weak and that is partly a reflection of the weak balance sheet of banks, companies and various other factors.

What is different this time around is the slowdown we have seen in the non-bank sector. The shadow banks which had stepped in back in 2016-2017 when banks stepped out, are in a pretty dire shape and banks are no longer in a position to step back in. The basic point is that the balance sheet issue which so far was confined to companies and banks, the twin balance sheet problem, has now become a triple balance sheet problem between companies, banks and the shadow banks.

India is more like Europe and it is more a bank credit driven economy. It is not like the US, which is more a capital markets driven economy. If credit flow in the system is constrained, it does raise the question -- what exactly is going to drive growth? My other concern would be that this process of balance sheet deleveraging that we have tried to do for the last three-four years. When you are in a cyclical slowdown where capacity utilisation has come down, the prospect of demand recovery and the time it will take to deleverage the balance sheet gets pushed out even further.

There are India specific factors that are causing a significantly larger than expected decline and unlike 2008-09, where you had a co-ordinated global stimulus that led to a V-shape recovery globally, that is not going to happen.

-Sonal Varma

The risk for India essentially is a fairly prolonged period of bottoming out process. The timelines for the private investment cycle to pick up get pushed out even further because that is a key ingredient into assessing the long-term growth trend for any country. The risk is if this does not get reversed quickly, the trend growth estimates will come down even further and that is the biggest concern.

According to your report, the eminent slowdown will lead to a compounding effect and pose increased challenges to the economy. Specifically how much can this potentially delay the deleveraging target and what will that in turn do to liquidity and credit within the system?
Most of us were in any case expecting the process of investment and deleveraging cycle to not pick up anytime in the near future. What this entire process of a lower capacity utilisation, lesser visibility on demand does is create spill-backs into the economy. When you have a weaker economy, if the NBFC sector was lending to specific SMEs and real estate developers, there will be worsening in their credit quality and asset quality cycle which will spill back into the system. The bigger issue today for India is really one of credit risk. It is no longer actually about liquidity because there is liquidity for those that want liquidity but because of the economic slowdown, the credit risk perception in the minds of investors and lenders has increased. So, it looks to us that the entire deleveraging cycle could take at least another 12 to 18 months, if not much longer.

We need to be very careful about distinguishing between a growth cycle recovery and the long term trend because if the September quarter GDP does fall below 5% as we expect, one would expect from a 12-month forward looking perspective that the rate of change will increase purely because you hit a trough on the growth rate cycle. Of course, monetary policy has been eased, liquidity is positive and that is leading banks to chase retail lending. Some of the discretionary side of consumption could bounce back in 6 to 12 months, but we could still very much be in a period where longer term investments are still moderating. That is the bigger challenge.

If I look at the realistic lay of the land, are you being optimistic when you say that we have hit an economic trough because the capital formation from corporates is not happening, big sectors are not drawing any fresh commitment whether it is telecom or power or for that matter, roads. For the capex cycle to pick up, corporates should feel comfortable about equity and they should feel comfortable about safety or their capital. Is that the missing link?
It is absolutely the missing link and the more high frequency indicators we have got for the month of October actually do not suggest that the October-December quarter is going to be significantly better than the September quarter. In fact, on an average, we are expecting the growth rates to remain around 4.2-4.7% range in the near term.

I would not really call it an economic recovery. Given India’s size and potential, that is a very suboptimal growth rate to have. In fact, for the next 12 months, we think growth is going to actually remain below potential. When we talk about growth bottoming out, a lot of focus tends to be on the year over year number. But I completely agree with you that it is really the longer term trend and the longer term investment outlook which matters a lot more and when you have the capacity utilisation coming down, lesser visibility on demand, debt clearly an issue, availability of credit clearly an issue the longer term outlook really deteriorates and that is a concern.

Given the factors that you have outlined, are we in for a single digit normal growth over the next two to three years?
Well of course, single digit. One, there’s the global context. The US and China are also slowing down and if we do see some pickup in global demand in 2020, there could be a potential tailwind in the second half of 2020.

Second, we have seen substantial interest rate cuts. This time around, I do not think it is actually trickling down to all the sectors. Especially, it is not trickling down to the sectors that really need capital. It might lead to more divergence between the haves and the have-nots. So, the discretionary side of consumption continues to get chased but that is a potential driver of recovery in the next six to 12 months.

On the whole, in the absence of a big global and capex upturn, we need to moderate our expectations. We have downgraded our numbers not just for FY20 where we are now expecting 4.9%, but even for FY21 where we have brought down our numbers to close to 6%. I do not think this is similar to the 2016-17 cycle where you actually had a V-shape recovery. This is going to be a fairly prolonged period of bottoming out process.

What really worries us is some of the surveys and real activity indicators as they stand today, them either close to or worse than the levels we had seen during the global financial crisis and we are not in a global financial crisis! So, clearly there are India specific factors that are causing a significantly larger than expected decline and unlike 2008-09, where you had a coordinated global stimulus that led to a V-shape recovery globally, that is not going to happen. So, we need to be prepared for a fairly long period of sluggish and below trend growth. That would be my key message.
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