If not for government spending, GDP growth would have been under 4%. A higher government spending will only mean higher fiscal deficit
Real GDP growth registered a below-expectations 4.4% y-o-y in Q2 2013 after 4.8% in Q1. Agriculture growth rose to 2.7% y-o-y in Q2 from 1.4% due to better monsoons, but GDP growth ex-agriculture moderated to 4.6% from 5.3%, Nomura says in its research note on GDP growth.
Higher government spending was the key saviour in Q2. Excluding that, GDP growth would have been under 4%. Private consumption growth hit at a record low, investment demand contracted and services GDP has also fallen sharply, sums up Nomura in its research note.
Downside risks to India’s growth outlook have materialized with financial conditions tightening much more than anticipated. Nomura in its research note says that it is cutting India’s real GDP growth estimates to 4.2% y-o-y in FY14 from 5.0% earlier.
Nomura has pointed out that firstly, a sharp pick-up in government spending (10.5% y-o-y in Q2 versus 0.6% in Q1) was the main positive driver of growth this quarter. If not for government spending, GDP growth would have been under 4%.
Secondly, domestic demand is going from bad to worse, argues Nomura. GDP at market prices, which better captures demand, grew at a dismal 2.4% y-o-y versus 3.0% in Q1. Private consumption growth slowed sharply to 1.6% y-o-y in Q2 (lowest in recorded history) versus 3.8% in Q1. In Nomura’s view, both discretionary and non-discretionary consumer demand is declining. Fixed investment contracted 1.2% y-o-y in Q2 on top of negative growth in the corresponding period last year. The slowdown in domestic demand is reflected in weakening imports. As a result, net exports dragged 0.6pp from GDP growth in Q2, less than a 1.2pp drag in Q1.
Thirdly, according to Nomura, the slowdown in industrial activity – both mining and manufacturing output contracted in Q2 – is reflected in slowing demand for services. While financial services have moderated, the biggest hit has been to the trade, hotels, transport & communication sector, which accounts for 28% of GDP. Growth in this sector slumped to 3.9% y-o-y in Q2, down from 6.2% in Q1, and a far cry from the sustained double-digit growth during its heyday. This sector has been an important employment generator and is closely linked to industrial activity.
Looking ahead, good monsoons and a gradual recovery in global demand are positives, but the question is whether they will be able to offset the drag from the ongoing balance of payment (BOP) stress, points out Nomura.
Nomura expects BOP pressures to continue over the next three to six months, which would have an adverse impact on the economy through multiple channels: cost-push inflation and margin pressures, higher short-term funding costs, asset price volatility and falling confidence, among others.
Additionally, with fiscal pressures building, Nomura concludes that the government will not be able to continue its current pace of spending without risking substantial fiscal slippage, implying spending will have to be sliced in the second half of FY14. Hence, the risk of a pro-cyclical fiscal and monetary policy tightening is rising and the downside risks to our growth outlook have materialized with financial conditions tightening much more than anticipated.
With the worsening current account and fiscal deficits and rushed policy-making, Nomura feels that Indian economy will have a tough time bouncing back, with balance of payments issues to be the cornerstone of her recovery
In a Special Report, Nomura Singapore is bearish on the Indian economy, critical of the Reserve Bank of India (RBI) policies and sees the Indian rupee (INR) depreciating to 75 to the US dollar, from current levels. “Based on our FX valuation analysis, INR is still around 10% overvalued, which means that spot USD/INR could move toward 75 to reach an equilibrium value,” said the note.
Nomura feels that economic recovery would be difficult considering that the current account deficit (CAD) and fiscal deficit have grown too large, putting the economy in a precarious position from a policy-making perspective. “The ability of the government to stabilise INR over the medium-term will be more difficult than Indonesia (another country suffering from similar economic dilemma), as the country suffers from both a large current account and fiscal deficit. According to Nomura, the cumulative current account deficit has worsened from -4% of the gross domestic product (GDP) in 2008 fiscal to a whopping -16.7% of the GDP in 2013 fiscal. This is expected to lead to balance of payments (BoP) pressures within the next three to six months, resembling the 1991 economic crisis.
However, Nomura feels that the RBI (and the government) has damaged its credibility in its fight to stem the rupee slide by taking several ‘reactionary’ and short-term measures which are of little value in the long-term. The note says, “Apart from the liberalisation of FDI caps, most of the government measures were quick-fix solutions and are unlikely to yield major long-term gains. The RBI’s interest rate defence has also failed. An interest rate defence is never a costless strategy. The RBI wants to control FX but without any collateral damage to growth, which is impossible to achieve. In our view the problem is that the RBI is trying to achieve inconsistent goals, which sends confusing signals, increases volatility, and damages the RBI’s credibility.”
The ability to contain he deficit without damaging long term prospects is a key challenge for both the government and the RBI, particularly the challenge of repaying some of the short-term bonds maturing in FY14, amounting to $172 billion. Another key issue is question of cross-border loans, which are almost the same levels of the reserves, at $273 billion. Unlike portfolio flows (equity and debt), cross-border loans are related to bank operations, investments and trade credit. Yet, if you consider our foreign exchange reserves, it is low compared to the obligations. India’s foreign exchange reserves are currently worth $278.8 billion, down 6% from the beginning of the year. “Foreign equity holdings as a percentage of market capitalisation is at a multi-year high of 24.7%. However, India’s vulnerability relative to Indonesia’s looks even higher once cross-border loans and short-term external debt are taken into consideration. The risk of outflows (especially for India) is growing given slow growth, the prospect of rising inflation and mounting risks of negative credit events,” warned the report.
It is also pertinent to note that India has just roughly 6-8 months of import cover, the lowest levels since late 1990s. In other words, India has enough reserves to guarantee imports for the next six months if the economy were to come to a standstill or currency crisis blows over. The threshold level is four months.
To plug the current account deficit gap and raise funds, Nomura believes there are six options for the government and policy makers to consider, apart from exports.
With the election year coming up next fiscal, Syrian crisis blowing over and, more importantly, the Federal Open Markets Committee (FOMC) meeting coming up mid-September to decide the quantitative easing tapering timeline, there is only so much room for policy makers to manoeuvre and wriggle India out of the crisis in terms of capital inflows and outflows. India needs to export a lot more than normal. A lot depends on Rahuram Rajan and his actions when he becomes the RBI chief. But he does not have magic bullets.
“Continuing concerns on the growth outlook, rising credit risks, deteriorating bank asset quality and worsening fiscal pressures suggest that risks remain skewed to the downside over the next six months. Thus, we maintain our negative view on India’s economic outlook,” the report concluded.
Continuing concerns over India's growth outlook, rising credit risks, deteriorating bank asset quality and worsening fiscal pressures suggest that risks remain skewed to the downside over the next six months, says Nomura
India’s manufacturing purchasing managers' indexes (PMI) slipped into the sub-50 contraction zone at 48.5 in August from 50.1 in July – its lowest reading since March 2009. The decline was due to a sharp fall in the output and the new orders sub-indices.
"(India's) growth is going from bad to worse. India's real gross domestic product (GDP) growth fell to 4.4% in second quarter (Q2), and with the average PMI much lower in Q3 (49.3 in July-August versus 50.5 in Q2), it seems domestic demand weakened further in early Q3 as well. Continuing concerns over the growth outlook, rising credit risks, deteriorating bank asset quality and worsening fiscal pressures suggest that risks remain skewed to the downside over the next six months. Thus, we maintain our negative view on India’s economic outlook over next 3-6 months," says Nomura Financial Advisory and Securities (India) Pvt Ltd, in a report.
According to Nomura, India's domestic and external demand has weakened. The new orders sub-index remained in contractionary territory at 47.5 in August from 49.5 in July, even as the new export orders index fell to 49.8 from 52.4. This suggests that both domestic and external demand weakened further in August. According to the survey, orders fell most in the intermediate goods sector, while consumer goods producers recorded a slight fall.
Even the output sub-index contracted for the fourth consecutive month (to 47.5 from 49.8), indicating that weak demand, competition and persistent supply-side pressures are forcing Indian manufacturers to cut production as well as inventories. The finished goods inventory sub-index fell to 48.4 from 50.1, commensurate with weak output. The new orders/inventory ratio fell to 0.98 from 0.99 and has been below 1.0 for three consecutive months, which is indicative of weak future demand, Nomura says.
According to report, however, price pressures have now eased. It said, "The input price sub-index eased to a 57.8 from 60.6, while the output prices sub-index fell to 51.8 from 53.4. With the currency continuing to weaken, the lower pass-through to output prices reflects weak demand and suggests that margins are under pressure."