The Reserve Bank of India (RBI) is betting benchmark interest rates at seven-year lows and the government’s recent move to inject a record $32 billion into struggling state lenders will be enough to revive private investment from a six-year slowdown. Governor Urjit Patel kept the repurchase rate at 6 percent on Wednesday and urged banks to pass on previous cuts to customers, saying that better transmission will enhance the allocation of money across companies choked by bad loans and sluggish demand. “Recapitalization of public sector banks may help improve credit flows further,” he said.
Investment banks like Goldman Sachs to Morgan Stanley seem to agree, with the former calling for three rate increases by mid-2019. Currently, markets are pricing in only about one hike next year as inflationary pressures build in Asia’s No. 3 economy and growth recovers from a cash ban and the chaos from the introduction of a unified goods and services tax.
Growth is expected to rebound to 7.5 percent in the year through March 2019 from an estimated 6.7 percent this year on the back of higher private consumption and investment demand, according to the median of 32 forecasters surveyed by the Reserve Bank of India.
Patel also flagged an increase in capital raised from the primary markets, saying that once this is used to set up new projects, it will boost demand and growth. Priced initial public offerings doubled to a record 749 billion rupees ($11.4 billion) in 2017, according to data compiled by Bloomberg.
Capital expenditure has started to pick up globally but has been bogged down in India by the “twin-balance sheet” problem, referring to festering bad debt on the books of both companies and banks. This turned into a vicious cycle, feeding into a growth slump that saw India ceding its crown as the world’s fastest growing major economy.
A catalyst was needed to break the cycle and the bank recap offers one. Economists at Goldman believe its positive effects should start flowing through the economy in the second half of 2018.
Ridham Desai, Morgan Stanley’s India strategist, says corporate balance sheets have delevered over the past two years and free cash flows are at all-time highs at over 10 percent of sales — which should be supportive of a recovery in private capex.
Stymieing the Recovery
Not everyone agrees. The Reserve Bank’s decision to leave rates unchanged will continue to stymie the recovery, according to Bloomberg economist Abhishek Gupta, who flagged downside risks to his 6.5 percent growth estimate for gross value added in the year through March 2018. That’s already lower than the RBI’s own 6.7 percent forecast.
Moreover, Indian companies have been running at only 70 percent of their installed capacity, indicating there’s still plenty of slack in the economy. A consumer confidence survey published by the RBI on Wednesday shows sentiment remains “pessimistic.”
Bloomberg Economics’ says RBI inaction keeps brakes on the growth recovery
However, Morgan Stanley points to increasing credit upgrades to suggest that things are improving. The credit ratio — number of ratings upgrades to downgrades — has improved to 1.9 times in the first half of this fiscal year from 1.2 times the whole previous year, Morgan Stanley calculates, indicating better health for the corporate sector.
“Taken together, these moves should help cement the growth acceleration and catalyze a private capex recovery,” said Morgan Stanley’s Derrick Yam and Chetan Ahya.