Fiscal And Monetary Boost To Revive Consumption, Says Neelkanth Mishra

Neelkanth Mishra: Frankly, that concern was actually misplaced. So, we saw that the central government continued along its fiscal consolidation paths in the July budget. In fact, they further reduced the fiscal deficit.

At the same time, what you will see at the state level is that, across states, more and more states are now offering income transfer schemes. So when Maharashtra did it in July, it was the 10th state of India to launch an income transfer scheme.

In fact, both parties in Haryana, both parties in Jammu & Kashmir and now both parties in both alliances in Jharkhand are offering income transfer schemes.

So the fact that at this stage of development in the economy, the growth in income inequality is a given. There will be a political response to it. So I think that's starting to happen at the state level.

In aggregate, if you add the Odisha programme, about Rs 1.9 lakh crore, or Rs 1.9 trillion, more than 1.6% of GDP is the income transfer happening to poor women across 11 states. And now, after the state elections, maybe 13–14 states will be added.

More than 18% of India’s women are now getting income transfer. So that's a separate thing, but if it happens at the state level—given that state deficits are capped at 3% of GSDP—I think at an aggregate fiscal level, that's less of a concern. So frankly, I would not correlate these results with the narrative on fiscal policy.

Neelkanth Mishra: Frankly, their results are very crucial for the states of Haryana and Jammu & Kashmir. I'm not convinced that they really have a big bearing on what happens at a national level.

There are political issues about the relative momentum of how vociferous the opposition is, how the government thinks about the process of reform.

But frankly, my own interpretation is that they have significant political repercussions, but as we think about the economy and the markets, they do matter for the people of Haryana and Jammu & Kashmir, but for the economy and the markets as it relates to the rest of the country, I think the impact would be relatively mild.

Neelkanth Mishra: That's a great question. We all have to understand from a distance what the Chinese policymakers may be thinking about.

I think it is very clearthat they are struggling with deflation. We have seen courtesy what happened in Japan, how bad it can be for the economy when deflation starts.

So, over the last 6–9 months, we have heard of spicy hot pot chains cutting prices, coffee chains trying to cut prices. And when restaurant prices start to fall, it's a very, very negative sign, in the sense that it suggests very weak consumer confidence. It suggests deflationary pressures on wages.

So I think, given how much debt exists in China, this would be very dangerous. So, the first objective of the Chinese policymakers is to reduce deflation, or at least bring back inflation, which is why the bazooka on the monetary side was very strong.

As you can imagine, because stock markets, equity prices are financial assets, the impact on them was very significant. The government there has kind of given up on trying to stimulate consumption demand, because that is generally fiscally messy. But they were, for a long time, trying to boost aggregate demand by getting housing to move. Over the last 2–3 years, they sort of deemphasised that.

Then, a lot of the bank lending was going towards industrial capacity. The loans to industry were growing at 25–30% a year. But over the last 6–9 months, we have seen that every single industry, from electric vehicles to battery storage to solar panels—all of these are very important sectors of the future—all the companies are now bleeding.

So they are not interested in taking more loans to set up more capacity. Therefore, their base money growth is 12%. Their broad money growth is 6% because loan growth is falling. The central bank is injecting more money, but the banking system is not creating enough because there is not enough demand for credit. Now this is a very dangerous situation if you have such high levels of debt to GDP.

Therefore, the first response they had was a very aggressive monetary one. The challenge is, and the problem is, that what the economy needs is a very strong fiscal response. Now, the fiscal response—which is why the market is disappointed —is not coming through, because fiscal responses or fiscal moves are generally very messy because what you're trying to do is take from one hand and give to the other. Monetary generally, there is a problem for savers, if you cut interest rates. But given that there's so much financial depression anyway. So their objective is to get inflation back. Given that unemployment is not a big issue and the population is falling, I don't think we should have expected a very big fiscal response.

Neelkanth Mishra: I don’t think that the India selloff by foreigners was directly linked to creating space for buying into Chinese equities and frankly, even the correction we are seeing today.

You know, if something moves up 25%, a lot of the people who are kind of anticipating this, or had been stuck in it, would try to exit. So, a sharp move up and a sharp move down, frankly, it's not a sign of anything for me.

The problems in India are also, I think, in the near term, we are seeing the economy slow down quite meaningfully. Many high frequency indicators have worsened meaningfully in the last 4–5 months and our expectation is that this is temporary.

As the government fiscal spending picks up, as the RBI is signalling that, from the quantitative side of money, they are easing a bit, and as all of those start to flow through the economy, it should revive starting January–February.

But I think the result season is going to drive cuts in earnings. So, some of what we are seeing in India is a reflection of our own weak economy, and not so much about people just dumping India to buy China. Now, given that the Chinese government has shown so far, they were least interested in these things, given that they have shown that they want to bring inflation back and then stabilise the economy and Chinese equities are very cheap, and therefore some reallocation will be permanent. I don't think they will go back to those kinds of P/E multiples again.

Neelkanth Mishra: I have held a view for the last several years, and it's not a very popular view. It is that the rural and urban divide is blurring, and this axis of rural is doing well and urban is not doing well and vice versa. It is something that analytically has lost value, in the sense that if someone picks up a motorcycle and goes to the nearest town and buys something, is that urban consumption, or rural consumption?

I think what is more interesting is lower income versus upper income. What we have seen in the last 4–5 months is that the lower income consumption, which was very weak, has kind of stabilised.

The upper income consumption—car demand, the demand for consumer goods, retail sales in modern stores—those were actually very strong but have started to weaken.

What should we think about going forward? I think the slowdown that we have seen is, because of a very negative fiscal impulse. Last year's central and state government spending was front-loaded. This year, central and state government spending is back-loaded, because of elections and then some rejigs happening at various governments. But I think the spending pool is there, and as the spending picks up, I expect that the upper and middle income consumption will again strengthen.

Remember that for the next several years, labour will be in surplus, capital will be in shortage. So, we are going through that phase of economic development where the bargaining power of labour will be lower than the bargaining power of capital, and that's generally a sign that upper and middle-income consumption will do better than lower income consumption. So that's an axis I find useful, and that's why I was never in the camp that this so-called rural recovery will happen. I'm not surprised that it has actually been quite different.

Neelkanth Mishra: In the second quarter numbers, as the previews have started getting published, we have seen cuts happening to industrials, to financials, to autos, to cement to several sectors, and even consumer staples. Many companies have seen cuts. Barring a few like, say, jewellery, etc, where the top line updates have been slightly better than expected, I think everywhere we're seeing weakness.

So the cuts will be broad-based, but I must say that these will be backward-looking, in the sense that, as the RBI signals through persistent overnight surpluses, or liquidity surpluses in the overnight market and quite possibly, as we see the new MPC, give its comments tomorrow, our expectation is that they will at least change the stance.

This is the time that they should ease the monetary conditions, given that global conditions have eased with the Fed cutting rates. I don't think MPC will be cutting rates, but on the quantitative side, I do expect some easing to happen. That is why, I think the bank earnings, the cuts that we have seen should be more backward-looking. Same for industrials. In our view, the capex cycle has turned, the real estate cycle has turned, the power generation cycle has turned and as the launches, the pre launches, and the sales start to translate into construction, you will see the economy getting some momentum back.

So for many of these sectors, as the market starts to get worried about the pace of earnings cuts or very poor results for the September quarter, I would actually be buying into that selloff, because I expect that with fiscal and monetary easing, the economy should start showing good signs of recovery by January–February.

Neelkanth Mishra: That's a very important question. Before we see what is going to happen in the future, it's very important to understand what happened in the past.

In fact, the growth slowdown that we saw between 2012 and 2021–22 was the investment ratio falling from 34% to 27% or of that 7% decline. The decline in household investment in real estate was 5%, 3.5% was government and public sector and private sector investment in machinery and there were increases happening as the government built infrastructure. So you can imagine that 5% of that 7% with just household investment in real estate. So I think that is the strongest change that I expect will drive the economy in the next couple of years, anything which is a construction proxy, I think with cement profitability being at a decadal low. Currently, the volume growth is very weak. I think the sector has been somewhat weak as a result of that. In our view, as construction picks up, I think that would be a good proxy.

On the power generation side, any economy as it grows, requires more energy. Incrementally, I think the share of electricity is going to be higher. Therefore, we are going to need a lot of capacity. In the last 7–8 years, we've not added much. Some of these stocks are very expensive. So maybe, the current weakness in power demand, where we are seeing negative numbers in September, August, can actually set the stage for some reasonable recovery as the next year comes closer.

Some of the machinery stocks can also be beneficiaries of this. Not so much metals, because steel in particular, I think, given what's happening in China, given that the Chinese sort of desire is to just bring some inflation back and not really restart investments in real estate, and sales of real estate are down by two thirds, I think construction activity is going to fall off.

I think the long-awaited slowdown in Chinese metals and steel demand is now a bonus, and that's something that can be an overhang on the profitability of Indian steel companies.

Neelkanth Mishra: So, this sector has already done pretty well. So as the inflows into Indian equities continue, even through the period of economic weakness, I think most domestic fund managers have already rotated into the defensives.

So what we have seen over the last four months is that IT, staples, pharma—they've all done well, despite the fact that there is not any meaningful change in their earnings trajectory. In fact, staples earnings, by consensus, are still seeing cuts. Pharma earnings are not changed at all.

IT has seen a bit of upgrade, but very, very minor, not justifying 25–30, times forward earnings. So even if a recovery were to happen, while incrementally, it could be positive news for the market, and maybe the stocks can respond to that, but I think the sector is really expensive.

What has happened though is that the growth prospects for the US economy, they're showing much more resilience, and as we had expected. We have to see what is driving this. Remember that in the last two years, their fiscal deficit has expanded quite sharply. Just like the sharp fiscal contraction in India and the last 2–5 months has given the slowdown in the domestic point here, it was the sharp rise in the fiscal deficit in the US economy, which actually has supported the growth.

So we don't know if in the last months of the fiscal, which for them is September, they actually had a much higher fiscal deficit. Let's see the data tonight. But there are several drivers there. I'm not convinced that the IT sector’s volume growth numbers in the next year or two are going to be meaningfully better than what they reported, which is why I will be underweight on the sector.