Oct 16, 2017
“If you look carefully, almost all Old Money secrets can be traced to a single source: a longer-term outlook.” – Bill Bonner
In the face of dismal expectations for earnings this quarter, we have witnessed a surprising IIP print at a four month high of 4.3%, lower than expected inflation at 3.3%, robust auto sales, good credit growth and strong rural metrics… there is more going on with the Indian economy than meets the eye.
We present the case that certain key trends help explain the surprising pickup in growth for the India economy, and lay a path for where we are headed.
Driver #1: Aadhaar & Credit
Credit’s positive impact on real economic growth is well established in the academic press. The government’s roll-out of Aadhaar, combined with requirements to link Aadhaar to bank accounts, mobile phones and investment accounts creates a transactional infrastructure on the basis of which credit can be extended efficiently and electronically.
India is possibly leap-frogging its way to a credit and electronic payment driven economy. Easy access to credit has multiplier effects, in particular bringing aspirational desires such as automobiles, homes, home improvements, appliances etc. within the easy reach of the middle and lower middle class.
Where is the data to prove this? Non-food credit by commercial banks has been rising each month this year, up from 4% to 8% as of September.
Private Sector and Rural Credit Is Growing
While public sector bank credit is languishing, private sector bank credit is gradually gaining momentum, running at around 18% YOY. Equally noteworthy, regional and rural bank credit is accelerating at 18% YOY growth as well (see charts below).
Bank Credit in 2017 Has Risen from 4% to 8%
Private Bank Credit is +18% YOY…
…And Rural Bank Credit is Accelerating
Credit by NBFCs & Housing Finance Co.’s Is Growing
Evaluating funding from non-bank sources to the commercial sector is equally informative. Net credit extended by housing finance companies has risen to INR 510 billion, up 53% YOY and NBFC funding has risen to INR 285 billion from 35 billion in ’16-17.
Housing & Vehicle Loans Are Increasingly Affordable
Ample credit availability based on borrower repayment history and credit scores, and strong demographics, have allowed consumption to remain buoyant. India’s credit to GDP remains low, at 52% of GDP. There is huge room to grow.
Driver #2: Rate Transmission
We have written often that rate transmission was likely to take 6 to 9 months post demonetisation to make its way to the consumer. It is happening.
Transmission Is Happening On Fresh Money Loans
RBI Policy has delivered 200 bps of rate cuts since Jan-15. Of that 200 bps, transmission on fresh money loans is now running at 193 bps. New loan rates are down substantially and that translates to higher purchasing power.
On existing loans, however, banks have been reticent on reducing the rate. The retail refinance market in India, one would presume, is still in its infancy and most consumers are not savvy on refinancing. Meanwhile, banks have likely been able to refinance their loan books lower, thereby increasing spreads and profitability.
Further, while private banks have been aggressive in reducing rates on fresh money loans, PSU banks and foreign banks have shown an unwillingness to do so. Private banks rates would seem lower than PSU bank rates, confirming our view that well-run companies will always sport a lower cost of capital.
Private Sector Banks Have Reduced Rates on Fresh Money Loans
NBFC Rates on Fresh Loans to Commercial and Personal Housing Have Declined
5 Year Corporate Bond AAA Rates Remain Lower Than Fresh Money Loan Rates
Rate Transmission Occurring in Real Estate…
Private banks and NBFC rate transmission is also evident on loans for commercial real estate, as well as in personal housing.
Finally, 5 year AAA corporate bond rates remain below the average lending rate on fresh money loans, demonstrating that firms with decent credit ratings have access to low rates to refinance debt.
Credit Upgrade Cycle at New Highs…
Refinancing and leverage reduction have likely been an important contributor to the upgrade cycle that we are witnessing in corporates, with credit upgrades at new multi-year highs.
The Credit Upgrade Cycle is at a Multi-Year High
The 5 year corporate AAA rate has been on a consistent downtrend, but the beneficial effects have not come through because of GST working capital teething pains. We would expect to see an improvement in the coming quarters.
Indicators for Consumption Remain Healthy…
More general indicators on urban consumption remain reassuring, aided by rate transmission. Passenger car sales have recovered smartly and are approaching trend levels last seen prior to demonetisation.
Passenger Car Sales Are Rising…
…A Sign of Consumer Health
Urban consumption is likely aided by transmission of lower rates, a minor wealth effect from household savings being redirected to equities, upward revisions in HRA for central government employees and implementation of the 7th pay commission at the sub-national level.
In general retail consumption activity reflected in personal loans from commercial banks suggest that the consumer remains in a reasonably healthy condition and his willingness to accept credit is a strong positive for the economy. The dip in personal loan growth during demonetisation is safely behind us, and the loan growth trajectory is firmly on track.
Personal Loans Are Accelerating… Credit Cards Are Growing Strongly
To sum it up, transmission is a proven policy tool for generating disposable income in the hands of businesses and consumers, and rate transmission has benefitted the consumer.
Driver #3: Structural Low Inflation
Crude oil prices have risen, commodity prices have risen and the rupee has depreciated. The consensus view, one that is shared by the RBI, had been that inflation would rise, as would input costs to manufacturers. However, inflation has remained surprisingly benign.
We would attribute this to the low CPI on food, +1.5% and credit goes to the government on managing food inflation better than prior administrations.
Equally important, though, is that demonetisation has eliminated black money from the housing system and rents appear to have declined.
Finally, ecommerce is playing a disinflationary role. A few years ago, prices rarely dipped below MSRP in the retail stores. Since the advent of large ecommerce players, discounting has become the norm, and price discovery is increasingly transparent.
Combined with the mass adoption of smartphones and technology, these trends are inherently disinflationary, not just in India, but globally.
Driver #4: Bottom of the Pyramid Rising
P.M. Modi alluded to the fact that substantial benefits have been passed on to lower income households. We concur.
A massive farm loan waiver that amounts to 50-100 bps of GDP is a transference of subsidy to the rural farmer.
Rural credit is rising rapidly. Rural consumption is demonstrating clear uptrends as well, in tractor sales, two wheeler sales, and three wheeler sales.
Rural Demand is Picking Up
Asset Quality & NPA Ratios Are Healthy… Except for Industry
Nor does it appear that the rural sector is particularly over-leveraged. Stress in asset quality is concentrated around industry. Services, agriculture and retail remain healthy.
We would also point to the IndusInd and Bharat Financial merger. The next leg of financialisation is underway, driven by credit, rates and government support to lower income households.
Driver #5: New Emerging Market
India has traditionally struggled to keep inflation under control and maintain currency stability. Not so anymore.
India has been able to sell bonds in its own currency and reduced external foreign currency denominated debt, creating lots of room for counter cyclical growth policy. Foreign reserves and fiscal prudence are amongst the best out there.
More generally, emerging markets are delivering consistent growth, whether it be China, India or a handful of other countries, at growth rates twice global GDP growth. Emerging market share or global profits is rising.
We are looking at emerging markets, with strong fiscal discipline and steady growth.
As a consequence, international and domestic capital is flowing into the country’s equity and debt markets, and FDI is flowing into business investment. Capital raised via capital markets is allowing private firms to raise funding for growth.
Outlook
We believe these drivers provide a reasonable story underlying the resilient and robust automobile sales, low inflation, credit growth and healthier rural consumer. The IIP data is a reflection of improvements in electricity generation, mining, power and higher capital goods output.
Rapid Change is the New Normal
It is noteworthy that the rhetoric on the economy, however, changes from month to month. Rapid change is also the new normal. Whether it be the markets, sentiment, or the global economy’s prospects, extreme changes in perspective are a new normal as fear and greed both rage.
A Global Coordinated Recovery is Underway
We have shared our views for some time now on a global coordinated recovery. This trend continues to move afoot. What has changed is a wider recognition of the increasingly benign climate for investors.
The Baltic Dry Freight Index is Confirming the Global Recovery
Sector Strategy
If our thesis on credit is right, then private banks, NBFCs and housing finance will do fine.
Credit, capital markets and autos remain attractive, and energy similarly remains a growth sector with significant barriers to entry and some longer term uncertainty.
Telecom appears to be bottoming in the coming months and as does Pharma. IT remains structurally impaired. Select sectors of real estate – commercial and affordable housing – are likely to deliver decent performance. Materials are likely to continue their performance as well.
Government spending may be finally coming through, but that is for us a cyclical, low predictability event.
Attractive Base Effects
Comparisons versus last year’s demonetisation impacted quarter, base effects should prove beneficial over the next 2-3 quarters. This could provide the impetus for optically better growth numbers, which will give markets a perception of health.
Investment Demand & Investment Subdued
Investment – private and government – remains subdued, and this is likely to remain the case with excess capacity still being nowhere close to worked down and leverage on large corporate balance sheets remains high. Government project and investment momentum is also weak, surprisingly, with the only momentum being visible in roads, highways, electricity and metro projects.
Portfolio Strategy
While a stimulus is certainly tempting from an investor’s perspective, the benefits that accrue to a low inflation, growth economy are sustained and long lasting. So, the government’s resolve to keep on the fiscal discipline glide path is commendable.
Earnings will deliver greater clarity this month and the next. However, it remains likely that the market will look forward, now that signs of improvement on the macro data are visible. The impact of earnings is now likely to be more muted.
With low inflation, the move towards a lowering of consumer inflation expectations is underway, and the RBI has more room for monetary stimulus if necessary.
The upshot: We were not willing to write off the structural bull market during the angst last quarter. We are certainly not willing to do so now.
Technical Outlook
The Nifty50 touched a new, all-time high of 10190.9 on Friday to close at a record level of 10167. In spite of FPI outflows, domestic inflows have helped index recover swiftly from last month’s low. Last three months of price actions have been range bound between 10170 and 9685 odd levels. Now sustaining above 10190 levels index will see breakout from this consolidation. Next level for index comes at 10530 and 10650 levels on the upside.
On the downside, recent swing low of 9685 becomes an important pivotal level for reversal of trend in the market. Immediate support zone for the market comes at 10000-9950, where the 10000 strike price put has the highest open interest suggesting a strong base for the market. INDIA VIX has also retreated to 11.26 levels from a recent high of 14.16 and supportive for the market.
