Slowing GDP Growth Highlights Need for Reforms

05 JUNE 2019

India’s GDP growth slipped more than expected to 5.8% year-on-year (YoY) in 4QFY19, tracking weakness in both agriculture and industrial sectors. Overall GDP growth for FY19 reached a 5-year low of 6.8% YoY. Gross Value Added (GVA) for the agri-sector turned negative for the first time since 3QFY16, possibly in response to low prices. Manufacturing growth fell to 3.1% YoY reaching post-demonetizations lows. Investment growth, which had been a key driver of GDP growth over the last 6 quarters, reversed sharply – also compounded by lagging exports. Services, the only major sector to have shown accelerated growth sequentially, grew by 8.4% YoY – a 7-quarter high.

With a sentiment-positive election outcome, India has avoided a fractious coalition at the center; however, macro challenges remain. Citi analysts list the areas in need of immediate attention from the government:

Rural Consumption: With 69% of the population and 50% of consumption attributed to rural India, rural wage growth remains essential to jumpstarting consumption. Citi analysts see a deep correlation between FMCG volumes and rural wage growth. Recent commentary from FMCG companies suggests a sharp moderation in rural demand heading into 1Q20.

Rural wage growth and FMCG volume growth move in tandem

Source: Citi Research, CEIC, AC Nielsen

Citi analysts believe that better transmission of increased MSPs, expansion of cash and other welfare subsidies are critical to provide an immediate boost to farm income.

Investment: As per the RBI, every rupee of capex by the central government increases output by Rs. 3.25, while an equal amount of revenue expenditure driven fiscal support (like those announced in FY19/FY20) has a multiplier of less than 1.0. In recognition of this, Citi analysts expect the government to focus on infra development through Roads (land acquisition, financing), Power (financial health of DISCOMs, coal availability), Railways, Defense (‘Make in India’), Oil and Gas (divestments, GST) and affordable housing.

PSBs: Accounting for 65% of total bank loans and 70% of all deposits, PSBs have suffered persistent losses in recent times, requiring frequent recapitalization. Citi analysts expect the government to continue on the path to consolidation of PSUs (their number reduced from 27 to 19 through FY18-19) and impose governance reforms.

NBFCs: Since the IL&FS default in Aug 2018, NBFCs have found it difficult to raise financing, facing tighter liquidity conditions. While the RBI has supported bond markets through OMOs and other alternative tools of liquidity injection, Citi analysts expect the RBI to provide a dedicated window for NBFC financing in order to avoid escalation of a liquidity issue into a solvency crisis.

IBC: While the IBC has helped improve credit culture, healthy recoveries and evolution of a market driven resolution mechanism, progress remains slow – with over 32% of the ongoing resolutions running over-time. Citi analysts believe that a prioritized expansion of judiciary infrastructure would free up bank capital and management bandwidth.

Recovery Rate of IBC vs Prior Regime

Source: Citi Research, Insolvency and Bankruptcy Board of India

In the backdrop of escalating global uncertainties, Citi analysts believe India may continue to receive FII inflows to sustain its current 56% premium over EMs. They raised their Sensex target multiple from 16x to 17x 1yr forward earnings (March 2020). The new Sensex target of 41,000 by March 2020 (previously 39,000 by Dec 2019) implies ~3% upside over current levels. Investors may continue to stick to their strategic asset allocation and ensure diversification in investment portfolios.

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