There is reason for optimism with many triggers for the uptick in India´s economic growth in evidence.
The global economy continues to show signs of deflationary pressures. While Japan, the third largest economy, is expected to grow a mere 0.3 per cent, the European Commission cut Eurozone growth forecasts for the 19-country bloc by 1.5 per cent this year and 1.3 per cent in 2017 in anticipation of the UK exit and reduced demand and investment. Meanwhile, the Brazilian and Russian economies are expected to contract 3.3 per cent and 1.2 per cent respectively, in 2016. On the other hand, South Africa, Singapore and Hong Kong are expected to grow anywhere from 0.2 per cent to 2.2 per cent. The Bank of Japan has kept the interest rate on deposits from banks at minus 0.1 per cent and the European Central Bank has maintained its deposit rate at minus 0.4 per cent. While China´s debt to GDP has ballooned to 260 per cent in a decade, Japan´s net debt has soared to 130 per cent of its GDP. Japan´s Government debt load is two and a half times the size of its annual GDP.
India defies global deflationary pressures The US and India economies are the only two economies in the world that do not show any significant signs of deflationary pressures. In fact, among the major economies, India is expected to grow fastest this year and the next. In its latest estimate, the Asian Development Bank expects India to remain on a strong growth path in the current and next fiscal, with GDP growth of 7.4 per cent in FY2017 and 7.8 per cent in FY2018. China is estimated to grow only by 6.6 per cent.
India´s external trade remains area of concern
Global deflationary pressures have taken a toll on international trade û recently the World Trade Organization (WTO) cut its forecast for global trade growth this year by more than a third to just 1.7 per cent. For the first time in 15 years, international trade is expected to lag behind the growth of the world economy. This year, trade will grow only 80 per cent as fast as the global economy according to the WTO, the first reversal of globalisation since 2001 and only the second since 1982. This global scenario has taken a toll on India´s exports, which fell for 18 straight months till May 2016. Exports witnessed some growth in June this year; thereafter, it again turned negative.
Most other external economic parameters of India remain firm
The Indian economy has the unique advantage of gaining from global pains. Crude oil prices have fallen about 60 per cent from their peak in 2014.
This has resulted in India´s oil import bill falling substantially from $143 billion in FY2014 to $112.7 billion in FY2015 and to a recent record low of $64 billion in FY2016, which is less than half of what India spent in FY2004. For the current fiscal, the import bill has been pegged at $66 billion. The crash in oil prices has also helped the Indian economy contain the inflationary trend despite two consecutive failures of the monsoon in 2014 and 2015. Fortunately, India´s gold import also fell by 77.5 per cent YoY to $1.11 billion in August 2016. For the period, April-August 2016, it declined by 60.5 per cent yoy to $6.08 billion compared to $15.42 billion in the corresponding period last year. This is a significant development for the external economy of India as it would lead to the saving of precious dollars.
Here are some other positive developments on the external economic front:
Primarily on account of the steep fall in the import bill of oil and gold, the current account deficit (CAD) fell to $300 million and just 0.1 per cent of GDP in the June 2016 quarter as against $6.1 billion (1.2 per cent of GDP) in the June 2015 quarter. This CAD in the June 2016 quarter is the lowest in the past 37 quarters.
India´s external debt rose by just 2.2 per cent YoY to $485.6 billion as on March 31, 2016. Interestingly, the short-term debt declined by 2.5 per cent to $83.4 billion from $84.7 billion a year ago and its share in the total external debt also declined to 17.2 per cent from 18 per cent last year.
India´s foreign exchange reserves are around an all-time high - from $275 billion on September 6, 2013 (when the currency crisis was at its peak), reserves have increased by $95 billion to around $370 billion now. One should not forget the FCNR (B) redemptions coming in October and November; however, we believe the redemptions will be met with no significant hiccup as RBI to its credit has hedged nearly 90 per cent of the requirement of dollars. This is likely to keep volatility under check to some extent. RBI´s foreign exchange forward book stands at $21.4 billion as in June 2016 to cover $25 billion (including interest) of 2013 FCNR (B) deposits.
Thanks to the comfortable foreign exchange position, the Indian rupee has also largely stabilised in the range of 66 to 67 against the US dollar.
Mild deceleration in growth in the first quarter of FY2017
India´s economy was the fastest growing major economy with a five-year-high growth rate of 7.6 per cent for the full fiscal (FY2016) on the back of robust manufacturing growth. However, our economic growth decelerated to its lowest level in six quarters in the April-June period of FY2017. GDP grew by 7.1 per cent in the first quarter of the fiscal year, against 7.9 per cent in the preceding three months, ie the fourth quarter of FY2016.
The index of industrial production also contracted by 2.4 per cent in July 2016, registering the worst performance in eight months mainly on account of declining output in the manufacturing and capital goods sectors. On a cumulative basis, the factory output in April-July 2016 declined by 0.2 per cent compared to 3.5 per cent growth in the corresponding period a year ago.
The eight core sectors of the economy - coal, crude oil, natural gas, refinery products, fertilisers, steel, cement and electricity - grew only by 3.2 per cent YoY in August 2016. However, this was better than the 2.6 per cent YoY growth posted in August 2015. Further, cumulative growth during April to August 2016-17 stands at 4.5 per cent compared to 2.4 per cent during the same period in FY2016. However, these developments are of concern only in the short term as many signs are visible for a significant improvement in India´s growth going ahead. Signs of shift in aggregate demand in the economy GDP growth in the first quarter of FY2017 was primarily dragged down by the agricultural and mineral sectors, which contribute 13.7 per cent and 2.5 per cent respectively to India´s GDP. These grew by just 1.8 per cent and minus 0.4 per cent respectively.
However, an imminent boost from the agriculture sector on account of a normal monsoon is likely to happen going forward. The area under kharif crop has gone up by 3.5 per cent to 1,058.48 lakh hectare compared to 1,022.61 lakh hectare last year. In fact, the cultivation of pulses is estimated to be up by 48 per cent - the same will help contain headline inflation as the food inflation basket is quite sensitive to the demand-supply conditions of pulses.
Globally, metal prices have firmed up in the past six months; for instance, zinc prices moved up as much as 30 per cent. Hence, mineral prices are expected to move up significantly - the same will be conducive for boosting domestic mineral production.
The pay hike to Central Government employees is expected to provide a significant push to the aggregate demand in the remaining quarters of FY2017.
Consumption of petroleum products grew at the quickest pace on a monthly basis in five years during August, rising over 11 per cent YoY to nearly 16 million tonne. It had increased 9.5 per cent YoY on an average in the preceding three months. Both diesel and petrol led the way, growing at 14 per cent and 25 per cent respectively on a YoY basis during the month. Diesel consumption surged to a near five-year high on a monthly basis in August, primarily driven by commercial transportation.
Robust fuel consumption continues to give us optimism on possible improvement in the industrial economy.
Import of India´s crude oil imports peaked in August as refineries stepped up purchases to meet record domestic fuel consumption. Indian refiners imported 18.81 million metric tonne of crude oil during the month, a 9.1 per cent increase over last year. This was the highest monthly purchase since at least April 2009. Rising oil import is a crucial positive indicator of the industrial economy.
While overall indirect tax collections went up by 27.5 per cent yoy, collections from the excise duty went up by 48.8 per cent yoy during the quarter of April-August 2016.
Even if the impact of duty hikes were removed, one could observe significant double-digit growth in excise duty collections. Robust excise duty collections are an indicator of improvement in demand for manufacturing sales. Direct tax collections have also increased 15 per cent YoY in the April-August quarter û this is a significant indicator of improvement in disposable income, which is a prerequisite for generating demand.
Passenger vehicle sales increased for the 14th consecutive month in August, driven by new launches, a favourable monsoon and the pay hike to government staff, prompting the industry body to boost its market growth projection for the financial year to 10-12 per cent. Sales of passenger vehicles have increased 10.74 per cent since the fiscal year began on April 1. Sales of two-wheelers also grew at a quick pace in August by 26.3 per cent.
Interestingly, banking credit growth also improved close to a double-digit rate at 9.8 per cent now; this had fallen as low as 7 per cent in the recent past.
These macro indicators on both the agricultural and industrial sectors provide a lot of confidence on shifting aggregate demand in the system vertically and, thereby, improving GDP growth and corporate earnings significantly in the near future.
Service sector also looking up
The services sector is not only the dominant sector in India´s GDP, but has attracted significant foreign investment flows, contributed significantly to exports, and provided large-scale employment. India´s services sector covers a wide variety of activities such as trade, hotel and restaurants, transport, storage and communication, financing, insurance, real estate, business services, community, social and personal services, and services associated with construction. The Indian service sector grew at about 10 per cent per annum and contributed to about 61 per cent of the country´s GDP in FY2016 whereas it grew 9.6 per cent in Q1FY2017, led by a 12.3 per cent rise in public spending and a 9.4 per cent increase in financial services and related sectors.
The aviation sector, the backbone of India´s service sector, has maintained high double-digit growth for the 25th month on a trot; domestic air passenger traffic surged nearly 24 per cent in August this year. An indicator of improvement in the service sector, service tax receipts were up 23.2 per cent in the April-August period of the current fiscal. The share of service tax has gradually increased, now contributing 14 per cent of the total tax collected by the government.
Government policies and the way forward The construction industry is a major contributor to India´s GDP, both directly and indirectly. It employs 33 million people and any improvements in the construction sector affect a number of associated industries such as cement, steel, technology, skill-enhancement, etc.
Despite many positive signs, activity in the sector appears to be quite slow currently. The prolonged slowdown in the real-estate market has resulted in a lot of unsold housing projects across India. Simultaneously, the construction sector is reeling under a severe shortage of skilled workforce. And shortage of construction sand and raw materials and political disturbances are also acting as growth deterrents in many areas of the country.
However, the pace on the ground does not reflect what lies in store for the future. For example, technological advancements will soon step up the momentum and expand the potential of this sector, acting as a growth catalyst. Further, the arrival of new construction technology and the entry of international infrastructure players into India is generating employment across a vast array of different skill sets.
Apart from the smart cities project, the government´s ´Housing for All by 2022´ will be a major game-changer for the industry. Increased impetus to the creation of affordable housing, along with quicker approvals and other supportive policy changes, will soon result in an increase in construction activity. Likewise, the Atal Mission for Rejuvenation and Urban Transformation (AMRUT) will bring in increased activity in infrastructure and related sectors.
Norms for FDI in 15 sectors, including real estate and construction development, have now been eased, with positive implications for these sectors and the larger economy. The introduction of GST will ease tax-related complexities in the construction sector and result in a major spurt in activity and growth. Township housing and infrastructure will also become major drivers for the construction sector in the immediate future. In most cases, the development of townships and their associated infrastructure happens in new corridors of our cities, and the government is extending a lot of support to develop untapped areas.
It is true that quarterly gross value added (GVA) at basic prices for the June 2016 quarter from the construction sector grew by a mere 1.5 per cent compared to growth of 5.6 per cent in the first quarter of 2015-16. However, with a significant number of positive indicators for the overall growth uptick and the government´s initiatives, we can hope for some credible improvements in the construction sector over the next two years.
All in all, better times lie ahead. What we are currently witnessing is a buffer period, in which various policy changes and other growth drivers are still loading into the system. It is only a matter of time before we see renewed growth and vibrancy.
Construction sector performance on the capital markets
The construction sector turned around in FY2016 with total net profit of Rs 1,220 crore as against total net loss of Rs 1,355 crore in FY2015. However, this sector under-performed on the capital markets. While the market cap of entire BSE listed stocks moved up by 15 per cent YoY in October 2016, the market cap of listed construction companies fell down by 2 per cent YoY. However, this relatively poor performance of this sector was on account of under-performance of L&T on the capital markets. As L&T accounted for over 69 per cent share in the overall market cap of the construction sector and its own market cap fell by 5 per cent YoY, it dragged down the total market cap of construction sector by 2 per cent.
For L&T, the profits from the entire infrastructure segment, which includes construction business as well, is around 50 per cent of total company profits, and therefore, the standalone construction segment´s contribution could be in the range of 1/4th 1/3rd of total profits of L&T. Therefore, if we exclude L&T, the market cap of the entire construction sector actually moved by about 6 per cent YoY.
The realty companies have done far superior performance on the capital markets as some of them received boost in the form of fund inflows from the private equity funds in the last one year. Some realty companies have unlocked cash from the assets, which were creating consistent lease incomes.
As far as individual companies are concerned, Ramky Infra and RPP Infra in the construction sector and IndiaBulls Real Estate and Ajmera Realty have done phenomenonly well on the capital markets in creating wealth for the their shareholders. These four stocks have created anywhere from 29 per cent to as high as 149 per cent rise in the market wealth of the stakeholders in the last one year.
With anticipated turnaround in the construction sector, we can expect a lot more wealth creation from the companies of the construction sector going forward.