Consumer driven demand, says DBS

The Indian economy expanded 7.6% YoY in FY15/16 (Apr-Mar) from 7.3% the year before.

Despite the improvement, recovery was uneven. On the positive side, growth was driven by consumption spending (primarily urban demand) and public investments.

On the dismal side, private sector interests stayed sluggish amidst a challenging external sector.

Exports fell sixteen straight months to Mar16, and offset the benefit from a narrower commodities’ import bill.

We expect growth to improve again to 7.8% in FY16/17 on the same dynamics. Private consumption is, however, likely to play a bigger role in boosting growth this year due to higher wages and rural spending.

Public capex spending will be constrained by fiscal targets, while private sector participation remains weak.

There are two catalysts – an increase in public sector wages/pensions and a strong monsoon – that will provide timely tailwinds to domestic demand. While a return to consumption driven growth is not without risks, we do not expect price pressures to run amok as in the past.

Jump in public sector wages to support demand

The government approved the Seventh Pay Commission proposals this month and raised public sector wages and pensions by 16% and 23.6% respectively. This once-in-a-decade exercise will increase all pay and pensions by a fitment factor of 2.57 times. Arrears for Jan-Jun 2016 will be paid this fiscal year.

However, the increase in allowances, including those for housing rents, was deferred.

As witnessed during the past pay commissions, demand for consumer durables (e.g. automobiles, clothing and footwear) and non-durables (e.g. recreational services) is likely to improve.

Demand was notably stronger during the Sixth Pay Commission in 2008-09 but this was due to the accompanying fiscal stimulus packages implemented to cushion the economy from the global financial crisis.

Higher wages/pensions will be a catalyst for private discretionary spending this year, but the boost to spending will be lower than the Sixth Pay Commission.

Incomes are also under pressure from a weak manufacturing/industrial sector, sluggish external sector and excess capacity.

On the fiscal front, the budget announced in February had already made room for a partial implementation of the pay commission proposals.

The latter, if implemented in totum, would have stood at 0.65%-0.7% of GDP. With the increase in allowances deferred for now, the fiscal burden is now lowered to ~0.5% of GDP and falls within the room available in the FY16/17 budget.

With indirect tax collections robust and increasing its weightage of the overall revenue mix, we do not see the risk of a large fiscal slippage.

But state finances might deteriorate slightly. Most states have not made room for this additional pay increase in their fiscal math.

This will keep India’s cumulative (central and state) fiscal deficit high at more than 6% of GDP, above most of its peers with similar debt ratings.

Onus to fall on consumption-driven growth, but not without risks

With the private sector still deleveraging, limited room for public capex spending, and exports under pressure, the onus will fall squarely on domestic consumption to boost growth.

So far this year, lead indicators have been moving in the right direction. Passenger car sales rose 8% YoY in Apr-May16, up from 7% last year and 4% the year before.

After headwinds last year, two-wheelers sales are off to a strong start this fiscal year. Retail loan demand was the only segment that rose in the past two years, while the industry and service sectors hit road bumps.

Overall household debt is less than 10% of GDP, signalling room for further growth here.

Consumption-driven growth is, however, not without risks. In the past, demand driven growth has proven inflationary. While India may miss its 5% target for CPI inflation in FY16/17, the risk of inflation running away is limited.

This is because low commodity prices, good spatial/temporal spread of the ongoing monsoon, partial implementation of the pay commission awards (particularly excluding a hike in housing rent allowance), government’s administrative steps and tamer inflationary expectations have provided a more conducive price backdrop.

Wage pressures are far from threatening given excess capacity and a modest upturn in rural incomes. Our CPI estimate for the year is at 5.4% YoY, from sub-5% last year.

We see room for a measured 25bp cut this year before benchmark rates plateau. The trajectory is also contingent on the new RBI Governor, composition of the monetary policy committee and (if) inflation targets are reviewed.

Nonetheless, inflation trends need to be watched closely in the months ahead, especially as consumption plays an increasingly important role for growth. Increasing weightage of horticulture will also keep food inflation prone to intermittent supply shocks and volatility.
In summary, helped by domestic tailwinds, India’s growth is relatively shielded from external risk events, particularly Brexit aftershocks and a slowing China. fii-news.com