Emerging Markets

India research: the economic backdrop

Over the past few quarters, we have witnessed a rapid deceleration in consumption patterns and growth in India, but Indian policymakers have started to take action to tackle this slowdown.
November 2019

Risk Disclaimer 

The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested. Investing in emerging markets is generally considered to involve more risk than developed markets.

 

Over the past few quarters, we have witnessed a rapid deceleration in consumption patterns and growth in India, with the recent quarterly economic growth of 5% p.a. for the quarter to June 2019, a five-year low. There is a lot of economic data to highlight the current weakness in the economy, for example, passenger vehicle and two-wheeler sales have fallen by 15 20% in the first few months of this fiscal year, which began in April 2019. 

Further anecdotal evidence highlights the extent of the slowdown, with one of the leading consumer companies that has a large exposure to rural India, stating that rural consumer volumes are currently growing by low single digits. The extent of this slowdown has caught most economic commentators by surprise and over the past several months, forecasts for growth in India have been revised down for the near future.

Risk Disclaimer 

The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested. Investing in emerging markets is generally considered to involve more risk than developed markets.

 

What is the cause of this slowdown and what is the government doing about it? There are several factors affecting the slowdown, including the previous tighter monetary policies of the Reserve Bank of India, several quarters of weakening consumer and business confidence, and the lack of significant structural reforms by the Modi administration. However, probably the most important factor has been the default to its creditors by the state-run Infrastructure Leasing & Financial Services (IL&FS) in September 2018, the largest infrastructure finance provider in the country.

 

Over the past few quarters, we have witnessed a rapid deceleration in consumption patterns and growth in India, but Indian policymakers have started to take action to tackle this slowdown.

 

Over the past twenty years, the company, which was considered ‘blue chip’, built debt to the equivalent of 18.7x its equity, with most of the debt used to directly finance large infrastructure projects in India. The company has put forward plans to reduce the number of projects it is involved in, putting 25 projects up for sale, and the government has appointed a new board to turn it around.

The IL&FS crisis has had an important ‘second derivative’ impact on the Non-Banking Finance Companies (NBFC) in India. NBFCs in India can accept medium-term deposits and make loans; however, they cannot offer payment facilities to customers like debit cards. Although NBFCs are registered with the Reserve Bank of India, there is no government guarantee to depositors in the event of a collapse. The availability of liquidity to the NBFC sector has reduced significantly over the past several months and this has been a major issue impacting the sector.

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As a result, a number of these NBFCs have slowed down lending to the consumer sector, where they typically provide loans to finance cars, two-wheelers and other consumer durables, and this has been a key factor behind the slowdown. Within the banking sector, HDFC Bank continues to benefit from a high quality deposit franchise, double-digit loan growth within their retail customer base, and tight underwriting standards, which ensure that non-performing loans remain low. Indian policymakers have started to take action to tackle this slowdown, with the Reserve Bank of India cutting interest rates once again in September 2019 and announcing measures to channel more liquidity into the banking system. The government also announced a bold reduction in both the headline Corporate Tax rate and a lower tax rate for new manufacturing companies, with the aim of boosting the economy.

 

Reduction in Indian corporation tax 

34.9%

Previous 

25.2%

Reduced

17.0%

New manufactures

We believe that this reduction in tax rates is the first step that the government needs to take to help resolve the current weakness in the economy. We would expect more measures to help improve India’s competitiveness and are hopeful for some further reforms over the coming six to twelve months. All of this could present some interesting opportunities for us to add to high quality companies, with potential further volatility in the Indian equity market over the coming months.