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ECONOMIC GROWTH APPEARS TO BE
RUNNING OUT OF STEAM. CAN THIS BE
CAUSED BY THE SUDDEN DEMONETISATION
OF NOVEMBER 2016 ?
According to the most recent data, economic
growth is indeed showing signs of
deceleration. The country’s GDP only grew at
a pace of 5.7% in Q2 2017, down from 6.1% in
Q1. Naturally one’s first instinct is to blame
demonetisation… then the implementation of
the unified Goods & Services tax. However we
feel it is important to go back further in time
and to realise that the slowdown actually
began after the peak in Q1 2016 – when GDP
grew at a pace of 9.2% year-over-year. At the
time, oil prices had turned around and the
regulatory measures aimed at deleveraging
banks had come into force (identification of
bad debts, higher provisions…). This led to a
slowdown in credit growth and a downturn in
economic activity. The sudden announcement
that 500 and 1000 rupee bank notes were to
be withdrawn – accounting for 88% of
fiduciary money in an economy where 80% of
transactions are still made in cash – only
served to amplify a trend that was already
well under way.
SO WOULD YOU SAY THAT GOVERNMENT
POLICY HAS HAD A TANGIBLE IMPACT ON
ECONOMIC GROWTH?
The disruptive effect of demonetisation is
undeniable in the short term. However, one
should also understand that this move fits into
the government’s long-term vision. Modi’s
administration wishes to curb the “black
economy” and bring India into the 21st
century; and one way to achieve this is by
increasing the role of banks throughout the
economy. This is also one of the reasons why
the unified tax system on goods and services
was introduced at national level last July, replacing 15 different regional tax regimes.
Of course the government’s aim here is to
simplify trade across the country, to increase
the tax base and to clarify the environment for
foreign investors.
However the new unified tax regime remains
complex, involving several rates which differ
whether applied to inputs or to final consumer
goods. Many economic agents anticipated the
fiscal change, preferring to reduce their
inventories in order to limit tax discrepancies.
This major countrywide fiscal reform
therefore appears to have had a negative
impact on output before July.
HAS THE GOVERNMENT REACTED TO THIS
SLOWDOWN?
The government apparently expressed its
concern over the most recent data published
(industrial output up 1.6% over one year,
down from 7% in June 2016). It announced
several technical adjustments to the unified
Goods and Services tax regime. These include
exempting a number of companies,
authorising the largest number to make
quarterly rather than monthly statements,
ensuring that exporting companies with cash
flow issues can be reimbursed faster by the
tax authorities, and finally, reviewing the
principle whereby the client is accountable for
paying the tax when making a purchase from a
non-declared company!
However the government will do more than
simply alter the enforcement of this symbolic
measure, which was only pushed through
after endless legislative debates. It has also
announced several measures designed to
support consumer spending in response to the
downturn recorded in the most recent data
estimations.
The government has indicated it would reduce
taxes on petrol and diesel and is planning
spending increases for the next budget.
In all likelihood, the upcoming local elections,
followed by the general election of 2019, are
not unrelated to these announcements.
SO THE INDIAN ECONOMY SEEMS DRIVEN BY
A DIFFERENT MOMENTUM THAN THE REST
OF ASIA?
Indeed, while the IMF continued to review its
growth estimates upward for most Asian
countries, the growth figures for India were
downgraded (-0.5 point in 2017). The IMF is
now expecting GDP to grow by 6.7% in 2017,
before experiencing a slight rebound in 2018
(+7.4%). It is important to remember that
India is rather closed to the outside world;
exports only account for 15.3% of GDP and
importantly, only 19% of total exports are
within Asia. In comparison, over 36% of
Chinese exports are shipped to other Asian
countries and exports weigh a little over 20%
of GDP. India is therefore much more sensitive
to domestic demand; furthermore, farming
accounts for a considerable share of the
country’s GDP (15%), which means the Indian
economy moves according to its own specific
pattern. This explains why the government is
keen to support domestic demand.
BUT BROADLY SPEAKING, HAVE THE POLICIES
IMPLEMENTED SINCE MR MODI CAME TO
POWER BEEN EFFECTIVE?
A major success was the central banks’ ability
to control inflation. After culminating at 12%
year-over-year at the end of 2013, the
country’s inflation-focused monetary policy –
based on a policy rate corridor and clear
communication – enabled consumer prices to rise 3.4% year-over-year in August. This also
led to the easing of monetary policy, which
was needed to stimulate investment.
Nevertheless, difficulties persist in extending
this policy to the real economy. The interest
rates applied to companies remain high,
particularly those charged by public sector
banks, most affected by the accumulation of
bad debt. The latter account for 7% of total
bank assets and rose 60% in 2016, in just
twelve months! According to recent
announcements, the government is
considering further recapitalising some of the
country’s public banks.
Another undeniable success was the reduction
of the country’s current deficit. This was
initiated in mid-2013, but has lasted, despite
rising energy prices and their unfavourable
impact on importing countries. Opening up to
foreign investors by easing administrative red
tape has meant that most of the current
deficit – 2.4% of GDP at end June 2017 – has
now been “covered” thanks to the net rise of
direct investments, thereby vastly improving
the sustainability of the country’s external
funding.
TO SUMMARISE, IS IT WISE TO INVEST IN
INDIAN EQUITIES TODAY?
It seems to us that the current environment is
a little less favourable that it is elsewhere in
Asia. While the demonetarisation and the
unique Good and Services tax are transient
and ultimately positive factors for the Indian
economy, we believe the declining demand
for credit, the situation of banks – and
particularly how they will manage the sharp
increase in bad debt, will reduce the
probability of a fast recovery in economic
growth. In light of these factors, the shortterm
outlook for the Indian stock market is
rather less favourable.
We are therefore underweight on India within our CPR GEAR
Emergents strategy relative to the MSCI
Emerging index.
However, opportunities for a
return to the market may arise at the end of
the year, or early in 2018, considering the
country’s rather positive fundamentals. We
are also encouraged by the upcoming
elections – as these periods tend to be
associated with stimulus measures – but also
by the magnitude of the correction that has
already impacted the market.
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