Growth indicators

Growth remains poor with 1QFY20 GDP growth came disappointing at 5.0%, lowest growth since March 2013. Slowdown was broad based and not driven by idiosyncratic factors like government expenditure or agriculture. Private consumption, which has so far been the most resilient part of GDP, plunged and imports were also down. Gross Fixed Capital Formation (GFCF) remained weak and exports growth also halved. Interestingly, government expenditure held on well. Bigger surprise was nominal GDP growth plunging to lowest in this series at 8.0% y-y. Weakness in nominal GDP likely to negatively impact tax collections which have so far been weak, corporate profitability and make the current debt & credit stress even more acute.

Real GVA also came lowest since Mar 2013 at 4.9% with the decline across segment except in electricity and Public administration. Agriculture growth was alright, and services was also tolerable (although 2 year low). The biggest disappointment was industrial growth at 2.7%, led by manufacturing at a dismal 0.6% y-y. Only electricity, gas and water supply showed some strength at 8.6% y-y likely due to hot weather related demand.

Recent high frequency indicators continued to reflect slowdown, with auto sales continuing to languish badly, June IIP declining to 2%, with only 8 out of 23 manufacturing group showed positive growth. Composite PMI for August also declined to 52.6 from 53.9 in July, with both manufacturing and services PMI declining. Bank credit growth and traffic data was also muted. Thus, it seems slowdown is lower for longer and pervasive in nature. Global environment remains weak and weak equity market has also soured sentiments.

Despite aggressive rate cuts, weighted average lending rate has not fallen significantly and clearly monetary transmission is trouble for the policymaker. Thus, even after some steps were announced by government & monetary and regulatory easing by RBI there are headwinds to a quick growth revival and we expect FY 2020 to be sub-6% growth against RBI estimates of 6.90%.

External trade

Both exports and imports remained weak in July, reflecting continuous weakness both in domestic and global demand. July trade deficit declined to lowest in 4 months, due to lower gold and oil imports and some pick-up in exports m-m basis. On y-y basis, exports growth remained disappointing and in negative for sectors like agriculture, textiles & leather, petroleum products and gems & jewellery. Exports of machinery, electronics and chemicals was in positive zone with growth in chemicals in double digit.

Imports growth crashed down further to -10.4% y-y, partially due to adverse base and decline in oil and gold imports. On a segment wise basis, growth trend remained low across the board with most segments in contractionary zone. Overall non-oil non gold imports remained dismal, reflecting broad based weak demand conditions.

We expect BoP to remain comfortable in FY20 with healthy surplus aided by low CAD and decent foreign capital inflows, particularly FDI. The risk is broad-based global risk-off resulting in massive EM outflows or large upmove in crude due to geo political risks.

Inflation

July inflation came broadly in line with expectations at 3.15%. On m-m basis CPI increase remained lowest in three years. RBI’s core inflation saw marginal uptick while core-core inflation, which excludes petrol diesel, Gold and silver declined. Food inflation declined y-y which is quite positive since base was adverse. Within food, vegetable inflation declined for second consecutive month despite adverse base. Divergence between rural/urban inflation narrowed marginally with rural inflation unchanged and urban inflation coming marginally down. Overall, number is broadly neutral to expectations and remains good. However, RBI had forecasted 3.1% in 2Q and with base effect negative there may be minor slippage there. Inflation remains within comfortable range and shall not come in the way of more monetary easing.

Portfolio Positioning & Market View

Although risk to achieving fiscal targets are increasing, but with global growth outlook remaining clouded and local growth surprising policymakers on downside, monetary policy will have to do more lifting to boost growth. Even liquidity has moved to surplus levels but large part of this is on account of seasonal movement of economic variables. RBI in June policy has indicated to relook the liquidity framework. We expect in order to facilitate better transmission; new framework would be critical given stance is “accommodative”. Liquidity premia in short end is still too high and does not correspond to current macro and RBI stance. Thus, we remain constructive on duration and likely liquidity scenario, and would advise investors to increase duration at current levels.

Corporate bonds are more aligned to quantitative aspect of money (liquidity stance) than price of money alone (absolute rate level). With policymaker’s inclination to re assessing liquidity framework, 1-3year AAA corporate bonds may look attractive on risk reward basis.

Another place where investors could increase allocation is in bond swap strategy. Swap markets are pricing in another 50bp rate cut while funding curve continues to remain elevated on account of uncertainty around durability of liquidity. Time is ripe for targeting spread between 2 year PSU AAA and rate swap spread. Current spread is at 190 bps vs last 5 year average of 120bps. As RBI unveils its new liquidity framework, we expect these spreads to narrow over the next 2-3 quarters to at least median levels.

Source: CEIC, Bloomberg, RBI

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