Strategy: GDP: More structural than cyclical challenges - Kotak

GDP: More structural than cyclical challenges. We believe market participants may be ignoring the structural challenges to India's GDP growth by overly focusing on the cyclical factors of demonetization and GST. In our view, weak investment demand (30% of GDP) is a far bigger 'structural' challenge for the economy. We are not sure how this will change in the short term. We note that continued weak investment will affect consumption eventually, high government expenditure notwithstanding.

Weak investment demand is a far bigger challenge

In our view, the general narrative about the slowdown in the Indian economy misses the negative contribution of continued weak investment demand. Market observers have largely focused on demonetization and GST as the 'culprits' for weak 1QFY18 GDP growth of 5.7%. However, we would note that investment demand (30% of GDP roughly) has been subdued for a fairly long time. Specifically, the GFCF component of GDP grew 1.6% in 1QFY18 and the slowdown in investment demand started from 2QFY17 (well before demonetization or GST) after strong growth in the previous three quarters (3QFY16-1QFY17).

Continued subdued investment demand will hurt in the future too

We do not see any signs of a meaningful recovery in investment over the next few quarters. This has become a 'rolling-forward' expectation for the past few years now. We first sounded the alarm on an 'investment cliff' in our October 2012 report (The coming 'investment cliff' and how to avoid it) given the imminent slowdown in investment in the 'traditional' sectors. We note the investment component (GFCF) of GDP has grown at 1.6%, 3.4%, 6.5% and 2.4% in FY2014, FY2015, FY2016 and FY2017. It is simple math that if 30% of the GDP were to grow at low-single digits, then overall GDP will struggle to grow at high-single digits.

Government consumption cannot do the heavy lifting beyond a certain limit

Strong growth in government consumption (roughly 11% of GDP; 21% growth in FY2017, 17% in 1QFY18) has supported GDP growth in FY2017. This reflects additional spending related to 7CPC-related increases in compensation (wages or pensions) of extant and retired government employees. The implementation of 7CPC-related increases by the 'balance' states will drive government consumption over the next few quarters. We expect government expenditure to stay at elevated levels with several state and general elections in India over the next two years. However, base effects will result in more moderate growth in government consumption over the next few quarters. FY2013-16 average government consumption growth was 3.5%.

Private consumption may suffer at some point in time without more sustainable drivers

We note that private consumption (roughly 55% of GDP) has held up reasonably well, partly supported by high government expenditure and also, consumer leveraging. However, we are not sure if private consumption can sustain at high rates without investment and job creation. Lastly, the impact of GST may be bigger than simple de-stocking in 1QFY18 if it was to lead to significant disruption in the unorganized economy. Anyway, we doubt participants in the informal or semi-formal economy would be keen on hiring and investing without a better understanding of the economics of their businesses in the post-GST world.

Source : Equity Bulls

Keywords