A New Orbit

Despite the travails and teething troubles of India's new economic realities, the future looks bright in the long term, defined by modernity, maturity, transparency and accountability. Change is the only constant. We have heard it a million times. Equally common is the human tendency to resist change, as most of us are inherently risk-averse. However, no progress comes without change, whatever its drawbacks or discomforts, risks or challenges. That's a reality no one can ignore. With a new government coming to power at the Centre three years ago, the Indian economy has witnessed sweeping changes in terms of policies and reforms. The pace of these reforms, in fact, has picked up over the past year and, admittedly, the learning curve has been steep. Initiatives such as demonetisation, the implementation of the Goods and Services Tax (GST), the Bankruptcy & Insolvency Code and the Real-Estate Regulatory Authority (RERA) have been discussed threadbare and their pros and cons analysed but one fact remains incontrovertible: They are realities that are here to stay. And, despite the short-term teething troubles, they are all expected to usher in a new era of modernity, maturity, transparency and accountability in the longer term. In our cover story, we try to gauge the possible impact of these realities on the Indian economy as well as players from the construction-related sector. However, let us first examine the current economic scenario, globally and domestically. Global economic scenario The global economic scenario remained vibrant over the past year. Despite the surprise win for Donald Trump in the US presidential elections, referendum for Brexit, slowdown in China and consistent geopolitical concerns creating uncertainties, leading global equity indices reached historically high levels. Significantly, though, many inward-looking policies adopted by developed nations resulted in some fears for developing countries, especially exporters to US markets. Over the longer term, failure to lift potential growth and make growth more inclusive could fuel protectionism and may delay market-friendly reforms. On the upside, the cyclical rebound could be stronger and more sustained in Europe, where political risk has diminished. Monetary policy normalisation in some advanced economies, notably the US, could trigger a faster than anticipated tightening in global financial conditions. That said, cyclical recovery continues and, as a result, global growth in the first quarter of 2017 was higher than expected in large emerging and developing economies. In addition, a few leading indicators for the second quarter show signs of continued strengthening of global activity. Indices of purchasing managers signal sustained strength ahead in manufacturing and services. As for overall global growth, pickup is projected to grow by 3.5 per cent in 2017 and 3.6 per cent in 2018. One more positive is that inflation in advanced economies remains subdued and generally below targets; it has also been declining in several emerging economies, such as Brazil and Russia. The Indian economic canvas In India, the immediate impact of the notable policy changes mentioned above was visible, with lower GDP growth for the preceding two quarters. Although the benchmark equity indices (a barometer of Indian financial health) touched all-time high levels, this was not backed by fundamental factors. It was mainly liquidity-driven; that too, especially from domestic fund flows. Although the macroeconomic factors were all improving, it was not equally visible in corporate earnings. Demonetisation and destocking ahead of GST implementation made a visible impact on sales volumes and, ultimately, revenues. On the macroeconomic front, let's start from the primary indicator: Inflation. The consumer price index (CPI) remained consistently below RBI tolerance levels. With the Index of Industrial Production being affected (owing to the expected impact of demonetisation and destocking), RBI got breathing space to cut the repo rate from 8 per cent to just under 6 per cent, where it currently stands. Unfortunately, all the benefits of the rate cut did not reach end-users. Nevertheless, lower rates have always been a positive for the growth of the Indian economy. In terms of GDP, for FY17 growth stood at 7.9 per cent in Q1; 7.5 per cent in Q2; 7 per cent in Q3; and just 6.1 per cent in Q4. Q1FY18 has been even lower at 5.7 per cent. The worrisome factor is that the gross values added for FY17 were at 6.6 per cent and are expected to be at 5.6 per cent in FY18. Even capacity utilisation levels declined to 72 per cent in FY17 from the levels of 74.6 per cent posted in FY16. Further, over the four quarters of FY17 and even through Q1FY18, no upgrade has been made for corporate earnings. As expected, valuations remain at elevated levels and seem clearly driven by liquidity. There are many bright spots as well. The fiscal deficit has remained under control and the government is likely to achieve its target of 3.2 per cent in FY18 (from 3.5 per cent in FY17) though there is growing pressure that the target may be eased to 3.5 per cent once again this year to create headroom for the government to continue public spending. Foreign direct investment (FDI) has hit a high of $60.10 billion as the government has eased the rules to lure global capital (especially for the Make in India campaign). The Indian rupee has strengthened since the beginning of 2017, with its sharpest run in the past few years. Thanks to falling crude prices and reduction in gold imports, the lower current account deficit (CAD) also was a positive. To put the figures in perspective, in Q1FY17 it was $0.4 billion (0.10 per cent of GDP); it was marginally higher at $3.40 billion (0.6 per cent of GDP) in Q4FY17. Although there has been a sharp rise to $14.30 billion (2.4 per cent of GDP) in Q1FY18, it seems under tolerance levels. Even institutional flows to equity and debt markets have been robust. All considered, with sweeping changes being implemented in the past year, some amount of discomfort is clearly visible among industry players and at the consumer level. Now follows a brief analysis of this flurry of reforms. GST: Confusing, but will result in expansion of tax base Among the several big reforms undertaken by the government, we believe the predominant theme has been the formalisation of the economy and thrust towards enhancement of the tax base. Towards this, the demonetisation exercise undertaken in November 2016 and GST have been the biggest indirect tax reforms since Independence. Despite the short-term impact on the economic front, these two reforms stand out as big drivers towards formalisation. Although there was a lot of confusion ahead of implementation of GST (because of the multiple tax brackets introduced), it is eventually expected to boost tax collection and supply chain efficiencies. It will also enhance the tax base and result in a swift shift towards organised trade. Apart from this, ease of doing business should also improve as layers of taxation reduce and business policies are decided based on fundamentals instead of taxation structure. The government has ensured that GST rates are not materially different from the existing incidence of taxation borne by goods, potentially offsetting the fear of inflation. As for the short-term macroeconomic impact of GST, GDP growth declined to 5.7 per cent in the June 2017 quarter. Economists believe that this is primarily owing to GST, the after-effects of demonetisation and the appreciation of the rupee against the US dollar. With regard to inflation, there were initial fears of inflation under GST but certain measures, like anti-profiteering and rate parity, helped keep it in check. In the first two months, there were some issues over division of GST into CGST, IGST and SGST; transition of credits; route of return filing; and uploading of forms with large line items. This apart, it is still seen as a beneficial move as it enables a shift to the organised sector from the unorganised one. The enhanced tax base and increased revenue collection are added advantages. Specifically for the construction sector, the implementation of GST has been perceived as positive as the ultimate implication is lower by over 200-250 basis points on most of the sectors related to construction. It is true that some amount of decline in sales volumes was visible; in the longer term, the sector as a whole stands to benefit. The sector-specific impact of GST has been elaborated upon in the sector write-ups. Demonetisation:Well-intended, but not well-executed Demonetisation also marks a thrust in the shift from unorganised to organised trade. It helped to drive the digitisation agenda of the government with a sharp uptick in digital transactions. Additionally, it has helped bring idle capital into the banking system. Consequently, the enhanced liquidity helped lower interest rates by a few basis points. In a way, demonetisation has accelerated the shift of savings from physical assets to financial assets, consistent inflows in domestic mutual funds being a case in point. Thus, taking into account all the factors at play, we believe that while demonetisation may not have been well-executed, it was well-intended. Further, it cannot be said with certainty that the demonetisation move completely eliminated black money from all sectors in general and the realty sector in particular, particularly where money that is already deployed is concerned. However, cash transactions wherein unaccounted or ill-gotten money was being parked in real estate have certainly become exceedingly difficult to execute. Also, the Benami Transactions (Prohibition) Act will help in identifying and vastly reducing the incidence of black money in real estate. Digital penetration: Another way to save on cost The government's demonetisation move has deepened the penetration of digital payments in the country by pushing people to pay for personal consumption items electronically. Even non-discretionary categories such as fuel and groceries are adding to digital transactions. Experts suggest that India has perhaps leapfrogged three to four years and achieved what otherwise could have happened only by 2020. While it is true that digital payments are coming back to earlier levels after cash levels easing and RBI issuing new currency denominations, India still spells a $900-billion opportunity for digital transactions. In simple terms, a 10 per cent increase means that India will save Rs 4 lakh crore by 2022, clearly indicating the potential of digitisation. Going ahead, with further penetration of Aadhar, the digitisation push may get easier. RERA: A diluted Act but positive step Real estate has been an investment asset for centuries. However, unlike the equity markets, there was no watchdog for the sector. Little wonder then, that it has been viewed with scepticism by many. With the objective to protect consumer interest and bring efficiency and transparency into the sector, the government implemented the RERA Act nationwide on May 1, 2017. Experts suggest that RERA will not only provide clarity on the roles and responsibility of various stakeholders but give a level playing field to differentiate between performers and non-performers. This Act will be beneficial to both developers and buyers. Although there are a few grey areas remaining in the Act, such as not defining the promoters accurately, no much clarity on the carpet area being sold and lastly settling the parity in payment issue (as builder and buyer have to pay equal amount of penalty if builder delays delivery or buyer defaults on payment): It is not wrong to assume that the time has finally come for homebuyers in India to breathe free and invest confidently in realty without fear of unscrupulous smaller builders or even larger organised developers taking them for a ride. A few fast-tracked cases and court orders in favour of consumers attest to this. Although the scenario is a bit difficult for builders at present, it is a great step towards a cleaner environment in the realty segment. Bankruptcy & Insolvency Code: A strong step to increase private capex An increasing number of non-performing assets (NPAs) for banks has been one of the major worries for the government as a major roadblock in increasing private capex. With gross NPAs at more than 9 per cent of total loans - and expected to rise to 10.5 per cent by March 2018 -stringent steps were required, especially with the practical failure of earlier schemes like SDR, 5:25 and S4A. The government can now authorise RBI to issue directions to banks to initiate insolvency proceedings against defaulters under the Bankruptcy Code. And RBI, on its own accord, can issue directions to banks for resolution of stressed assets. It may also form committees with members of its choosing to advise banks on resolution of stressed assets. The Bankruptcy & Insolvency Code is a time-bound process and seeks to reduce the time to resolve a default case to less than a year as against the average time of over four years currently. It has already been implemented (with seven companies shortlisted) and the results have been astonishing. Further, owing to its intervention, over 250 cases have been resolved, which would otherwise have languished in the courts. Future watch In conclusion, there can be no denying that the policies implemented have severely affected the construction and infrastructure sector. However, we believe that, with time, these will serve as engines to future growth. As for the present, we expect India's GDP growth to moderate to 6.7 per cent in FY18 from 7.1 per cent in the preceding year. With regard to earnings, since the beginning of Q3FY17, the forward EPS has not been upgraded. Given the current slowdown in industrial activity and credit growth, it would be nanve to expect sustained earnings recovery to revive in the short term. However, revival is expected in H2FY18. As for the construction sector, opportunities will abound and public spending will continue to inject momentum to the economy. The roads sector has witnessed strong traction; orders have picked up consistently over the past three fiscals and we expect more public spending to occur as we head towards elections in 2019. Affordable housing is another segment where large public spending is anticipated, giving a boost to demand for building materials. As the NPA issue starts to get resolved, one can also expect private capex to begin. Although times have been tough for India Inc in terms of coping with new realties, these are important steps that will propel the country into a whole new orbit.