India May Be In The Midst Of A Structural Slowdown, Warns Kotak’s Sanjeev Prasad

Our view is that the slowdown is more a structural slowdown than a mere cyclical one. If you look at GDP composition, then typically there are four big elements ⁠—private consumption, investment, government spending and net exports.

The two elements which are pushing India’s GDP growth have been household consumption and government spending. Of late, we have started seeing a slowdown of both these drivers.

Our worry is that if you look at private consumption, then that has been sustaining at a high level because a lot of households are willing to allow the saving rate to be lower than what it was historically. If you look at India’s household savings rate, that used to be around 23 percent in early part of this decade, which has now come down to 17 percent. In other words, it means that consumption has been growing a lot faster than income, which has led to a decline in savings.

That brings us to a structural issue which is that income is not growing at a reasonably high rate and we are not creating a sufficient number of good quality, high paying jobs. That is one big structural problem which we are seeing.

The other growth driver has been government spending. And that has been running on the back of India’s consolidated fiscal deficit being at very high levels and, of course, there is a natural limit on how much you can keep growing government spending without compromising the fiscal somewhere. That’s where we are. As India moves to more fiscal consolidation, government spending will also slow, which will remove one of the big drivers of economic growth over last three-four years.

Both these elements—which is household consumption and government spending ⁠—we have concerns over.  If these start slowing down, then the economic slowdown will be longer than what we assumed.

If you look at basic point of the savings rate going down, that means consumption as a proportion of household income and GDP is going up. That is basic arithmetic. If consumption is growing very fast and if income is also growing very fast, then we don’t have a problem. But is it a situation where income is growing slowly but consumption is growing fast? It is probably the latter.

There is no good quality job data available. But if you look at what is happening in three broader parts of economy, I don’t think that many jobs are being created in the formal economy. In the informal economy, we have seen some kind of disruption because of demonetisation, GST and the NBFC liquidity problems. Also, farm income has stagnated over the last few years. Farm prices are being static and, in some cases, they have gone down.

So, income is not growing faster but somewhere households have continued to consume by cutting savings. But at some point of time, households will start feeling uncomfortable, thinking that we have already cut savings to a very low level and maybe we have to dial back on consumption. This is function of India not creating good quality jobs.

It is already happening. If you see, for example, autos stocks have come down pretty painfully for the last few months reflecting the slowdown and that is very evident. You have significant year-on-year decline in volumes. So, there is no getting away from the fact.

If you look at the consumer staple names, thankfully the volumes are still growing over there. So, you’re not looking at a situation where we are seeing a volume decline. As far as consumer staples are concerned, it is slowdown, but the 5-6 percent volume growth is quite reasonable. So, there the (earnings) multiples are still holding up but even there, over the last 12-18 months, the stocks haven’t really done anything and, in some cases, the stocks are actually down. So, you’ve already seen a de-rating of (earnings) multiples that people are willing to pay. But they are still not at a level where people will feel very comfortable buying them.

As for the financials, basically which finance consumption, so far credit growth has been very robust. But how long that can sustain if there is a slowdown in demand for the underlying asset? And one of the big drivers of credit has been personal and unsecured credit loans. At some point of time, the banks will also take a call that maybe it’s not a good strategy to keep on growing this part of the business or they would probably start seeing a credit slow down too.

So, you could possibly see some de-rating even in the very high-quality consumer names and also the financials or private banks which finance consumption. So let’s see how it goes.

I think there is some amount of understatement because you have a fair amount of spending which has moved off-balancesheet. There is a debate about what comprises off-balancesheet and whether some of these entities, which are now doing investment which earlier the government was doing, whether they are self-sustaining or not. The government will like to believe that the railways can fund capex on its own balance sheet but I am not sure and more clarity is needed on the railway balance sheet to have a better handle on this. Another example is Food Corporation of India. I don’t think FCI has the P&L to support the debt it is sitting on currently. I don’t know how to treat that part. May be that should be treated as part of the government balance sheet.

It is all about how you want to treat off-balancesheet numbers.

At about 3.3-3.4 percent, which is the central fiscal deficit, and another 2.93 percent, which is the deficit for states, you are running a deficit of 6 percent-plus. If you look at most of the last five to six years, India has been running a fiscal deficit which is close to 7 percent, which is among the highest in the world. So, that is not sustainable.

One of the fallout of the high fiscal deficit is that monetary policy is also getting blunted. One of the challenges in the last few years is that the central government is raising a lot of money from the National Small Savings Fund. It is somewhere between Rs 1.2-1.3 lakh crore every year now, over the last two-three years. That is financing central government’s fiscal deficit apart from government bonds, which central government issues.

The problem is that this is acting as some sort of floor for bank deposit rates because the rates on the NSS schemes are higher than bank deposit rates. So, the banks are struggling to bring down the deposit rates.

You have two challenges over there. One is that the national savings rate is not going up. And as of now, bank deposit rates are lower than credit growth. Naturally, the banks are not in a position to reduce deposit rates. On top of it, you have bank deposits, which could have come into the banking system, which are getting diverted to the government in the form of National Small Savings fund.

We did some analysis on this. As much as 20 percent of incremental bank deposits are flowing into the National Small Savings Fund. That is a large number, which is moving away from the banking system.

That is hurting full transmission of rate cuts by the RBI. This year RBI has cut the repo rate by 75 basis points. But we have hardly seen a change in the MCLR or deposit rates of banks. The banks are not in a position to cut deposit rates and then naturally they can’t cut lending rates. That’s the real challenge on the monetary side.

In a way, the government fiscal deficit and large borrowings are resulting in a classic crowding out of the private sector. Even if we like to believe that the RBI has scope to cut rates more and may be that can result in some stimulus for the economy, but I am not very sure that transmission is taking place. In India, bond yields have come off very sharply, which is fine as the RBI is also doing a huge amount of OMO bond purchases. But bank rates are not coming down and India is driven more by bank credit than the bond markets. Also corporate bond yields have come down to some extent but not as much as government bonds.

I don’t think this monetary stimulus is working in a way.

It is (a risk) at the individual (entity) level, but for the broader economy, I am not sure whether I should be significantly worried about it. This is not like the infrastructure problem, which we had two years back.

When we look at the NBFC issue, it is more to do with Housing Finance Companies and the exposure to developers, where there may be cash-flow issues. If you look at the total amount of loans of real estate developers put together, between money given by banks, NBFCs and private equity/ real estate funds... all that put together will be Rs 5-5.5 lakh crore. In the context of the total size of India, the banking system, that is 4.5-5 percent. That is not the end of the world.

Besides, everything will not go bad. Even if we take 1/4th of that and assume that it goes bad, that is about 1-odd percent of the total size of the banking system and NBFC loans in the country. I don’t think it is a system wide problem. It will be problem for some of the players such as some HFCs, assuming some developers are not in position to repay their loans. Hopefully, this is not something which will play out.

It is possible that some of the developers start facing challenges of repaying loans they have taken from HFCs, who will find it tough to repay their loans then, which they have taken from debt mutual funds and banks. That’s where the whole situation will come to an end.

Let’s see where the situation pans out. Ultimately,the housing market has to pick up, for cash flows of developers to pick up.

That is where I think the government could do more in terms of housing. It has announced some steps in the budget but I am not sure if it is sufficient to kick-start the housing market and that’s where we think the real pain could be. If you have a lot of developers ultimately raising their hands and saying that they are not in a position to complete their projects and they have a lot of unsold inventory in the country, that will be a problem.

Given the general slowdown in the country, general concerns like jobs not being created, automobile industry showing bad numbers, everybody being somewhat pessimistic, then people are going to postpone some of these decisions when it comes to large-ticket items like homes. Also, given the fact that the government also raised the taxes on the rich, who would probably be the natural buyers in the luxury market, you could see a further slowdown over there. And I think a bulk of the problem seems to be more in that luxury market than in the affordable market. The affordable market is, I think, doing quite fine.

So if you start seeing a further slowdown in the high-end real estate market, then it is possible that some of the developers could default eventually. As of now, we haven’t seen any and I hope we don’t see that going forward. But given the lay of the land, I would think there could be some issues with some developers, which could result in some problems for the housing finance companies and for the banks and the debt market.

It is a worrisome sign. Is it reflecting a sharp slowdown in the economy? Or is it a situation where banks doing haphazard, rash lending which is what is now coming out? It could be a combination of all these things but it is still a worry.

The problem was earlier largely confined to infrastructure-related sectors, like your iron, steel companies, road developers etc. But of late, you’re seeing some of these companies in different sectors turning non-performing. This could mean you are still seeing challenges in the economy, clearly one of which is that there is not enough demand.

So yes, it is definitely a cause of concern but thankfully these are smaller companies compared to what we have seen in the last three-four years, so it is not going to derail the banking system but it is a pain point nonetheless, I would say.

I think it is a combination of the two.

When you are looking at investors buying into India what you are looking at ultimately is the growth story. Somewhere people are getting reconciled to the fact that you would probably see some challenges, which we spoke of earlier, in the Indian growth story.

If that is the case, will you see a slowdown in growth of a certain company and a compression of margins? Does it make sense to give the (earnings) multiples you are paying for this company? Keeping in mind that most of the consumption sectors and stocks in India are trading at rather rich multiples, investors are probably factoring in super high growth rates.

Somewhere there is a reconciliation between the assumption that the market has, with whatever we are seeing on the ground, which is low growth. So I think the stocks will remain where they are, maybe come off a little bit, the multiples may get de-rated over time. That is probably how things will play out. I hope you don’t see a situation where the market comes off very sharply.

Having said that, if you look at the bulk of the market, except for the top 20-30 names, many stocks have come off very significantly. When you talk about the market, you have a very bi-polar market. You have 30 stocks which are doing fine, the others in the market are struggling and are down 30-60 percent. A bulk of the market will fall in the second category and not the first.