“India’s GDP growth has slowed sharply to 5 per cent in FY13 from 9.3 per cent in FY11, we expect a pickup in FY14 to 6.4 per cent, above consensus of 6.1 per cent,” the global brokerage firm said in a recent report.
With market concerns about leverage on corporate balance sheets, high bank non-performing loans (NPLs), and limited room to ease interest rates, consensus expectations are for a sluggish growth outlook continuing in FY14, Goldman said in a note.
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The key to an improvement in activity during FY14 is a pickup in the investment cycle. Including greater government capex, falling rates, policy reforms to ease bottlenecks, and manufacturing export growth will help drive an improvement in investments.
Goldman Sachs identifies five reasons for a gradual pickup in growth from the second half of calendar 2013 -
Upcoming general elections and expected fiscal stimulus:
India's general elections are scheduled in the first half of the next calendar year 2014 (1H2014) and possibly even earlier, i.e., in late 2013. Prior to the general elections, there are state-level polls in six states over the next eight months.
The year before the elections are generally associated with increased government spending. Indeed, government spending (as a percentage of GDP) has increased the year before the elections, in each of the last four general elections. This has also been associated with a higher fiscal deficit, thus imparting a positive stimulus to the economy.
With large increases in spending funded by optimistic projections on privatization and telecom receipts, Goldman thinks that the fiscal deficit may come above the budget. Indeed, there are strong incentives for the government to spend, especially given the current state of the economy. Therefore, broking firm envisage a positive fiscal impulse to the economy in FY14.
Lower interest rates to stimulate economic activity:
Even though the Reserve Bank of India (RBI) has gradually been reducing rates, there is considerable skepticism in the market about its impact on investment demand.
According to Goldman's analysis on the relationship of interest rates and investment demand, a 1 per cent decline in short-end rates (3-month CD) leads to a 2.7 per cent increase in Gross Fixed Capital Formation (GFCF). The impact happens with a lag of four quarters. They also found that a 1 per cent fall in the 10-year government bond yield raises the Index of Industrial Production ( IIP) by 2.6 per cent, but with a lag of only two quarters.
Rise in interest rates is normally seen as a key determinant of the investment cycle. The significant easing of rates post-global financial crisis (GFC) led to a sharp jump in investment activity during 2009-2010.
In case the RBI were to ease policy rates and/or liquidity further, short-end rates may continue to decline and investment demand could increase further.
Policy, reform push to fast-track projects:
In the past eight months there is a significant push from the government to kick-start the investment cycle. Since September 2012, the government has taken a number of steps to boost business confidence and increase activity. The steps include fiscal, infrastructure, and FDI (foreign direct investment) reforms.
“There is a push to make government-owned companies (PSUs) spend their surplus cash to kickstart the capex cycle. Faster land and environment clearances, which the government is pushing for in part through the CCI, will likely also help,” said the Goldman Sachs.
The broking firm expects the cumulative impact of these actions to begin to be reflected in activity data from 2HFY13, and be more significant in 4QFY13 and beyond.
Global economy can act as a tailwind
Goldman does not expect commodity prices, and oil in particular, to rise. Indeed, oil prices have been driven lower in recent weeks to below our 2013 average forecast of US$110.
Oil has a key impact not only on India’s current and fiscal deficits, but also on its inflation and growth. Gold, another key import, is also showing a significant decline.
This would have the effect of not only reducing the current account, but also encouraging a shift in private savings from physical forms such as gold to financial assets.
Some green shoots are emerging in activity data
A number of economic indicators are suggesting a bottoming out of economic activity. The IIP has shown a gradual increase in qoq terms since November 2012.
Following several quarters of decline, projects under implementation showed a small uptick in the March quarter.
“If the 2013 monsoon season is a normal one, it may lead to a bounce in agricultural production. Historically, when weak monsoons have been followed by a normal year, it has led to a sharp rise in agricultural production,” says Goldman Sachs.
With an estimated 50% of the population still in agriculture and related activities, this could have a significant impact on rural demand. The broking firm thinks that this impact will likely be felt only after the monsoons, i.e., from September 2013 onwards.