The new note you have come out with, talks about the similarities you have drawn to now and the 2003-2007 period in India. If you can start by explaining what are those readings which tell you that the capex cycle in India is actually taking off?
Chetan Ahya: Essentially we are arguing that the best way to think about this cycle is to compare the investment growth trend in this cycle versus the 2003-2007 period. So, during 2003-2007, we had seen the investment to GDP ratio go up from the trough of around 28% to the peak of 39% by CY2007.
In this cycle, something similar is happening. We saw investment to GDP troughing at 29% in 2020 and 12 months ended March 24, we are expecting it to have already risen to 34%. Going forward, we are expecting further rise to 36% of GDP. So, this is an important driver of growth and the reason why it is important is because the growth is driven by investments and there is a lower chance of the country facing macro stability risks like inflation or widening current account deficit.
That is exactly what happened in that cycle as well. Inflation remained very well behaved in the range of 5-5.5% despite GDP growth averaging over 8%. Similarly, the current account deficit also behaved right until the middle of 2008 when oil prices had shot up to $148. Even then, the current account deficit was below 3%. We think that this is an important driver in this cycle, just like it was in 2003-2007 period and gives it more sustainability in terms of growth outlook.
So, you are making a case that now that the capex to GDP is actually troughed out, it may cross the previous peak of 34% and may rise all the way to 36%. The day I read this note my guest on the show was Sanjeev Sanyal and he was making a point too that there is a reason this time the breadth of growth is pretty wide and according to him durable. Do you see durability in this growth and breadth also coming in?
Chetan Ahya: Yes, that is right. We have initially seen that it has been driven within capex by public capex picking up and now we are seeing growth broadening out within investment to private investment picking up. And on the consumption side, it has been more evident on the urban consumption side but we are also seeing early signs of rural consumption improving.
So, both on the investment and consumption side, we are seeing growth broadening out. But the key anchor to this cycle will be investment growth and consumption growth will be a bit slower than investment growth. But it is actually necessary to have consumption growth underperforming investment growth because that is how you will get sustainability to the growth cycle because if it is investment driven, then we are creating capacities for growth to ensure that there is not much pickup in inflation and at the same time if you have investment driven growth, you would create that income growth acceleration. From income growth, you can see pickup in consumption. So, you will have decent consumption growth; it’s just that investment growth will be stronger.So, yes, investment growth will be stronger than consumption growth is what you are saying. You did say that we are seeing early signs of at least some bit of a rural recovery coming in. When you look at it in the last year, none of these FMCG companies actually have managed to post anything above a 5% volume growth, very few rare cases have come in in terms of that. What is your thought on that? How slow will that recovery be then?
Chetan Ahya: I think we should probably not expect a big acceleration in rural consumption growth in terms of FMCG companies’ volume growth for the December quarter. According to AC Nielsen, this has picked up to around 5% to 6% and I do not think that there should be a significant acceleration from there and the urban consumption on FMCG will probably still continue to do better in the range of 6% to 7% that is the kind of numbers we think will be comparable to the overall GDP growth which we are expecting to be averaging around 6.5% over the next five years. We think that these numbers are fine. The concern that the FMCG companies have is the pricing power. Now, to the extent to which earlier they had increased prices because of high commodity prices and now they have cut prices, that has affected their nominal revenue growth and which is why you hear the sort of feedback from them that their rural sales are not doing well, but it is more because of the pricing effect and we think that that pricing effect will correct as we see some normalisation going forward that will help their nominal revenue growth.
What are your two issues? One is that up till now, bulk of the heavy lifting, at least to start with on the capex side, was done by PSUs or the government side and now there are early signs that the private sector is catching up. How is the capacity utilisation across corporate India right now? The second part is there is a lot of first to terms of this government, a lot of work done on infra, etc, capex and now there is so much talk of next generation reforms. Any thoughts on the impact it could have on the capex cycle?
Chetan Ahya: I think there is enough in the economy in terms of demand for the corporate sector in the private sector to start doing capex and they have precisely started to do that. But there are two factors which have meant that there has been some slow recovery in private capex. Number one is that for a long period India had gone through challenges in a way that the corporate sector did not gain confidence. We had seen a severe amount of volatility over the last 10 years.
First, there was a taper tantrum and then you had seen demonetisation. In between, in 2014-15, China had gone through big deflation and slowdown. Then we had GST implementation, then you had trade tensions, then Covid. So, the corporate sector never really saw a two-year period of solid gains in domestic demand to have that confidence and they had been in the last three-four years before Covid, even taking up deleveraging of their balance sheet.
So, it is going to take some time for them to gain that confidence. Now that we have seen nice two years of domestic demand recovery, we are seeing the early signs of private capex picking up. The second factor which has been affecting their confidence is the weakness in exports. Now, exports are still pretty sizable if you take the share of the top line for the manufacturing sector and that has been weak for almost all of 2023. But going forward, that should improve too.
So, with the strength in domestic demand continuing and external demand improving, one should see further pickup of private capex. Of course, there might have been some holding back of investments, especially for the greenfield projects because of elections and once elections are done, we think you should see a much stronger pickup in private capex with all these three factors supporting them.
What are your thoughts in terms of the interest rate cycle, both in India as well as globally?
Chetan Ahya: Globally, the Fed and other developed markets will be cutting interest rates. We are expecting the Fed to cut rates from June of this year. There is a risk that they might delay it by one or two months but at this point of time, our base case is that they will begin cutting rates from June. And in this FOMC meeting that is coming up, we think that the dot plot will be showing that the Fed will maintain three cuts in this year.
Again, there is a risk that they might show two cuts instead of three, but in our base case, Powell is firmly at three cuts in 2024 and that is where the median dots will probably be lining up. What this means for India and Asia is that we expect Asian central banks also to begin cutting rates after the Fed begins to cut rates. We do not think, except for the Bank of Korea, any of the central banks in the region will begin to cut rates before the Fed does. As far as India specifically is concerned, there are two conditions that need to be satisfied.
Number one is that core inflation and headline inflation should converge at around 4- 4.5% and the second is that growth conditions should have softened a bit, particularly credit growth for RBI to take up a rate cut from June as well, but of course there is a chance that growth continues to surprise on the upside. In that scenario, we think RBI may hold on and not cut rates in June.
RBI governor two weeks back told us that he is expecting closer to 8% GDP growth this year and perhaps 7% next year and that is the direction most are taking. What is your own estimate on the growth front this year and next?
Chetan Ahya: If you look at the last quarter’s GDP numbers, GDP growth was at 8% but the GVA number was pretty much close to our expectations which is around 6.5%. We think the underlying growth trend in India is at 6.5% and that is the number that we have for the next financial year as well. There is a good chance that growth surprises on the upside, but at this point of time, 6.5% seems more likely rather than the 8% number which was caused because of one-off effects of tax payments and subsidies accounting for GDP calculation.
