Long haul for investors

It’s been an interesting few days. India suffered its fifth successive quarter of slower growth, and August auto sales numbers also suggested that, if anything, Q2, 2019-20 will be even slower sequentially, compared to Q1, 2019-20.

The government announced a merger of multiple state-owned banks. Tax collections through 2019-20 have been consistently well below projections. Non-performing assets have started rising again – not surprising given poor corporate performances. The Reserve Bank of India (RBI) has just transferred Rs 1.76 trillion to the government in a controversial measure.  Market indices lost further ground in a truncated week for Indian stocks. The rupee slid some more.

On the global stage, Britain’s Brexit plot has become even more convoluted. The authorities seemed to have caved in to the protests in Hong Kong, shelving the controversial extradition legislation that sparked it all off. Crude oil prices fell as energy markets adjusted to downgrades of demand projections as another round of US-China tariff hikes kicked in.

Most industrial commodities dipped in what is now a long-term bear market. Globally, the Economist commodity indices indicated that metals as a group have dropped 9 per cent year-on-year while all non-food items (including non-food agricultural, and energy) are down 18 per cent. Gold is up 27 per cent Y-o-Y with 7 per cent of the rise coming within the last month.

There are two major ongoing debates about the underlying causes of India's slowdown.  One, is it structural or cyclical? Two, are there more problems on the demand side or supply side?  There are obvious political dimensions to these debates.  

More pertinently, policy action would be influenced by the official narrative.  On the face of it, there are obvious structural issues as well as cyclical reasons that have led to the deceleration.  Land acquisition problems, poor infrastructure, a badly designed and implemented Goods and Services Tax (GST), the twin balance sheet issues, rigid labour laws, and a huge fiscal deficit are all structural issues. Hard policy decisions will be required to address these.  

The other “debate” should not even be a debate.  A low inflation scenario and low corporate revenues are a clear sign of demand collapse. The ill effects of demonetisation are still being felt since demand has fallen steadily since. Falling automobile sales is one indicator that points to lack of big-ticket demand – manufacturers are cutting back production. At the other end of the consumption scale, biscuit makers are also cutting production. Low demand has, in turn, led to job losses, which means a bad feedback loop where demand is being further impacted.  

The RBI has cut rates four times in succession. It is now trying to improve the transmission of those cuts by linking commercial rates to the repo rate. Opening the tap hasn't worked so far but it may eventually help to improve demand. Many businesses fervently hope that consumption will kickstart during the Puja- Diwali period, though that seems unlikely at the moment.  Unfortunately, the government doesn't have room to expand spending, which makes the most obvious tool for pushing demand — higher public spending — a risky proposition.

The positives for the Indian economy are low inflation and low commodity prices, especially low energy prices. Given global trends, there is a good chance that the commodity cycle will stay bearish for quite a while. Low metal and energy prices would prevent the trade deficit from spiralling up any further.  It also implies that most manufacturers will not have to cope with higher input costs.

The structural problems have to be tackled to put growth into sustainably higher range.  Labour laws and land reforms remain political hot potatoes, which no government has been comfortable about tackling. Bank mergers may help to shore up damaged balance sheets for a while but it won't necessarily stem the NPA trends without PSU banks being allowed to operate without interference.  

GST remains a mess and this is the easiest fix.  No other country has put together such a complex GST code. Compliance with India’s GST is difficult, and there have been persistent complaints from exporters about slow refunds. Instead of piecemeal tinkering, a rebooted regime of fewer rates, fewer exemptions, faster offset and refund processes would make sense.

Every indicator suggests the growth recession could continue for several quarters. Investors have to be braced for the long term. The stock market is quite likely to head south for a long period.