Economy back to high growth path; crude at $80 is a red line
Globally, the environment for growth recovery continues to be favourable.
The twin shocks of demonetisation and GST implementation affected India’s growth rate, which troughed at 5.7 per cent in Q1 of last fiscal. But it bounced to 6.3 per cent and 7.2 per cent, respectively, in Q2 and Q3.
We may end the year with a respectable 6.8 per cent growth figure. Low fiscal and current account deficits spelt macro relief for the economy during FY2018, resulting in lower inflation and exchange rate stability. The issue is this is in danger of being undone by the recent spike in crude.
What is in store for the economy in FY 2019 and beyond?
There are clear indications that the economy is on rebound. There is a global consensus that India would re-emerge as the fastest growing large economy in the world in 2018. The IMF projections reveal a lot.
Global growth, according to the IMF, ticked up to 3.7 per cent in 2017 -- the most impressive growth since the Great Recession of 2008-09. The multilateral lender expects global growth to get better at 3.9 per cent for this year and next. The table shows that among the large economies, India is projected to achieve the best acceleration in growth.
Globally, the environment for growth recovery continues to be favourable. The US is powering ahead with an impressive growth of 2.7 per cent. Unemployment in US is a 40-year low at 3.9 per cent. Inflation is under control at around 2 per cent. Europe is stable and China is slowly decelerating. International trade has picked up, aiding global growth revival.
In India, GDP growth dropped to 5.7 per cent in Q1 FY18, but from thereon, accelerated to touch 6.3 per cent and 7.2 per cent in Q2 and Q3, respectively. IIP, which has been above 7 per cent since November 2017, marginally slipped to 5 per cent in April. CPI inflation is under control at 4.5 per cent. Q4 corporate results are good and indicate strong revival in rural and urban consumption.
GST collections in April crossed Rs 1 lakh crore for the first time. We are likely to end FY 2018 with growth rate of 6.8 per cent. Growth is seen to accelerate to around 7.5 per cent in FY2019. However, there are some major headwinds that might impact this expected recovery.
The major worry is the recent spike in crude. Crude has risen by more than $10 a barrel since April. The RBI had assumed a rate of $68 for 2018, but Brent crude is now flirting with $80.
Every $10 rise in crude raises India’s inflation by 10 bps and negatively impacts GDP growth by 30 bps. Therefore, if the high oil prices sustain, that will be a source of worry. India’s trade deficit, current account deficit and fiscal deficit will all deteriorate.
The ‘twin deficit issue’ will come back to haunt policymakers. In that scenario, the RBI will turn more hawkish. Already, the 10-year bond yield has spiked to around 8 per cent. This sharp jump in the cost of capital is negative macro news.
There is no more room for passing the burden of the crude price rise on to consumers. The government has gone on record that excise reduction will be considered if crude goes beyond $75. Therefore, some excise duty cuts are on the cards.
This is inevitable when elections are fast approaching. But the flipside to the excise cut is it will expand fiscal deficit. The government turning more populist as election nears is another worry.
Rate hike in the offing?
The benign inflation scenario that the RBI projected in its last policy is unlikely to last. The projection of 4.4 per cent for FY2019 assumed crude at $68. Apart from the crude shock, there are other key factors like the proposed hike in MSP, narrowing of the output-gap and the depreciating rupee that will stoke prices. The RBI will certainly turn hawkish in the June policy and the present trends indicate two rate hikes this year. This is not good news from the market perspective.
Credit pain point
As the economy accelerates, credit demand would pick up. PSU banks, which account for 70 per cent of India’s banking system, are totally unprepared to meet the credit demand.
The regulatory and investigative overkill, along with capital constraints, have hugely impacted the PSU banking system. Of course, this is good news for healthy private banks and NBFCs.
Correction in smallcaps and midcaps
The correction in midcaps and smallcaps has been sharp. The excessive valuations of the small and midcaps had crossed levels of safety, rendering them vulnerable to correction. This has happened now.
Mutual fund restructuring also has contributed to this correction. As on May 18, the smallcap and midcap indices are down 14.06 per cent and 10.61 per cent, respectively, while the Nifty is up 0.61 per cent for the year.
Some small and mid-caps have been butchered. If the market corrects further, this segment is likely to bear the brunt of selling and price erosion. It will also provide some good buying opportunities in quality smallcaps and midcaps.
We are headed for volatile days. Since valuations for markets globally are at elevated levels, there is the risk of correction at any time. Emerging markets particularly are vulnerable to capital flight that can be triggered by the rising bond yields in the US.
The domestic political scene is turning foggy. The incessant flow of money into our markets through mutual funds, particularly SIPs, is imparting great resilience to our markets. Also, corporate earnings are set for sharp revival.
Therefore, there is certainly room for optimism. But the investor stance should be, ideally, cautiously optimistic and the investment strategy should be conservative and defensive in 2018. The economic and political waters are turning turbulent; investors should sail safely.