Why 2018 will see sustained growth for Indian economy
The year 2018 promises to be a year of sustained recovery for the Indian economy. While many analysts are not fully convinced about India's growth trajectory, the reality is that the economy has returned to its high growth path.
Stagnation in private investment has often been cited as a key constraint for the growth story, having fallen from 29.8 per cent to 28.9 per cent of GDP in the second quarter of 2017-18 (constant prices). However, over the past few months, the current government has been focused on creating an enabling environment for private investment to recover. For example, the proposed bank recapitalisation programme should increase growth in public sector bank (PSB) lending. Bank credit is critical to the recovery in private capital expenditure.
There are signs of green shoots in this sector as well. Bank credit had been slowing over the past few years owing to the problem of non-performing assets (NPAs). However, data from the Reserve Bank of India reveals that outstanding bank credit grew by 9.6 per cent year-on-year (YoY) in November 2017 after growing at 7.1 per cent, 6.5 per cent and 6.2 per cent in the previous months. Looking at data on sectoral deployment of bank credit, one finds that credit growth to micro and small industries has picked up in the months of August, September and October 2017, having declined continuously between March and July 2017.
While credit growth in private banks has been growing at a healthy rate, the growth rates for PSBs were much lower. With the proposed reforms, we should see PSBs' credit beginning to grow in the coming year.
Furthermore, with the recently passed Insolvency and Bankruptcy Code and the proposed Financial Resolution and Deposit Insurance (FRDI) Bill, speedy resolutions of NPAs should free up space in PSB balance sheets for fresh lending. In fact, many leading investment banks are predicting a recovery of private investment in 2018. For example, in a recent report, Morgan Stanley predicted private capital expenditure to rebound due to increased corporate return expectations. According to them, with consumption and exports recovering simultaneously, capacity utilisation and corporate revenues should increase.
While the October 2017 Index of Industrial Production (IIP) results were termed as a disappointment by many, a closer look at the results reveals a resurgence in both capital and infrastructure goods, another sign of investment picking up. While capital goods witnessed a contraction in output from April 2017 to July 2017, since August, this sector has been witnessing a continued expansion in output, growing at 5.2 per cent in August, 8.2 per cent in September and 6.8 per cent in October 2017.
A similar story emerges in infrastructure/construction goods sector. Also , manufacturing PMI tells a similar story. The index touched 52.6 in November 2017 up from 50.3 in October 2017, indicating a significant expansion in the manufacturing sector. Of particular importance are the findings that employment growth was at its fastest since September 2012 and that the rate of expansion of output was at its highest since October 2016. IIP results for November should reflect the increase in output as predicted by PMI.
Another important indicator is headline inflation, which surged to 4.88 per cent in November 2017. Analysts have been quick to argue that increasing inflation will pose significant threats to growth over the next year.
However, close inspection reveals that the increase in headline inflation has been primarily driven by increasing fuel and food prices. Food prices in turn have been driven by an increase in the price of perishables. The increase in prices of perishables is transitory in nature and likely to recede in the coming months.
Oil prices remain a concern. Increased oil prices lead to an increase in inflation and the current account deficit (CAD), owing to a higher import bill. Organisation of the Petroleum Exporting Countries (OPEC) has predicted that excess oil inventories that depressed oil prices over the past three years will be eliminated through sustained production cuts by OPEC members and Russia. However, the International Energy Agency (IEA) has another view. IEA predicts that non-OPEC supply growth, backed by US shale production will outpace demand growth, negating any gains made by OPEC through production cuts. Thus, the outlook on oil prices can go either way. If shale production continues to increase, then oil prices may not increase further than the levels being observed at this point. It is unlikely that oil prices will exceed $65 a barrel in 2018, as several analysts have predicted.
Furthermore, there are signs that demand is recovering as well. Exports, after a blip in October 2017, recovered to post a healthy growth rate of 30.6 per cent in November 2017. Indicators such as domestic car and two-wheeler sales have been robust as well. In November, sales of passenger vehicles grew by 14.3 per cent YoY and sales of two-wheelers grew by 23.5 per cent YoY. Two-wheelers have often been termed as a barometer for rural demand. Thus, by this measure, one can infer resurgence in rural demand after the shock of demonetisation. Sales of commercial vehicles, often termed a lead indicator have registered impressive growth. Overall, commercial vehicle sales grew by 50.4 per cent YoY in November 2017. This is not a one-off phenomenon. Sales of commercial vehicles bottomed out in April 2017, where it fell by 22 per cent YoY.
Between June 2017 and November 2017, the average growth rate in sales of commercial vehicles has been 20 per cent YoY. Clearly, there has been a sustained recovery in this sector.
With transitory GST and demonetisation issues fading out, an expected revival in bank credit, improved corporate performance and increased demand will lead India's economic recovery in 2018.