The economy has clocked a stellar 8.2% y-o-y growth in the three months to June, bumped up by a very weak base. However, given the several global and domestic headwinds, the momentum is unlikely to sustain. With the base effect wearing off, the global economy looking like it will decelerate cyclically on the back of trade wars and India’s elections due in Q1FY20, few economists expect the economy to grow at more than 7.2-7.3% in the second half of 2018-19. Already, there is less liquidity in the system and money is becoming costlier, as is clear from the State Bank of India’s move, last week, to hike loan rates by 20 basis points. The central bank has curbed lending by about a dozen state-owned lenders and, consequently, many SMEs are sourcing their loans from NBFCs which charge more. Loans could become even more expensive once RBI raises policy rates later this year, as is expected due to higher imported inflation on the back of elevated crude oil prices and a weaker rupee.
At a time when demand isn’t looking up meaningfully, higher interest rates would tend to stymie investments. Fixed investment increased by a much slower 10% y-o-y in Q1FY19 compared with 14.4% y-o-y in Q4FY19, driven almost entirely by government capex. However, given fiscal constraints, the government may not be able to invest significantly more. For the economy to grow at a sustained 8%, private investments must kick in meaningfully, and there is little evidence of that; in fact, as a share of GDP, gross fixed capital formation slipped in Q1FY19. Few business groups, save for a few large ones, have the equity capital to set up new projects. In this context, reports that banks will not support infra projects—where they have badly burnt their fingers—is not encouraging. Indeed, while the bond markets may have deepened over the last couple of years, and will support top-tier firms, companies with relatively weak ratings are unlikely to be able to mop up money at affordable rates. In fact, borrowings from the bond market have been sharply lower in the June quarter with fewer banks participating. Much of bank credit is being channelled into retail loans which, in turn, is driving private consumption.
After growing at under 7% for six quarters, private consumption staged a strong recovery in Q1FY19, at 8.6% y-o-y on a strong base, and well above the average of 7.5% between 2014 and 2016. Given that the rural economy—especially the non-farm segment—is faring well and nominal rural wages have bottomed out, driven by a good rise in non-farm wages, consumption should hold up; the availability of more cash in the system should also help. However, the increase in government consumption, which slowed sharply to 7.6% y-o-y from 16.9% y-o-y in Q4FY19, is unlikely to sustain. Also, the smaller drag from net exports in Q1FY19—a big surprise—can be attributed largely to GST-related tax refunds issues having been sorted out. With the global economy set to slow and the trade wars intensifying, however, it is unclear how India’s exporters will fare despite the weaker rupee. This is a big concern given how the current account deficit is expected to widen to around 2.7-2.8% of GDP this year.