Green shoots! Really?

A 45-point diagnostic test for checking signs of economic revival



“There is not a sprig of grass that shoots uninteresting to me,” said Thomas Jefferson. It seems the whole financial world is now catching on to this mindset. Investors, economists, analysts, fund managers et al are busy digging into economic data — looking for possible ‘green shoots’, a popular phrase to describe signs of economic recovery.

It has been more than a year since RBI Governor Raghuram Rajan first talked of spotting ‘green shoots’ in the Indian economy. Even in the latest monetary policy address, he spoke about a recovery in manufacturing. However, some of the green shoots got shot down over the year — by failing to maintain the growth momentum.

To get a holistic view of where the economy is headed, we tracked close to 45 critical indicators (lead indicators or otherwise). Here we looked at short-term as well as slightly long-term data to decipher any reversal or reinforcement of trends.

To give a green flag to green shoots, we checked if the year-on-year growth for the month of June ’16 or July ’16 has been higher than that for December ‘15. And we compared latest growth figures with those reported two years back — to assess the structural trend.

The economic pie

The expenditure method has been used to analyse the components of GDP where it is computed as a summation of consumption, investment, government expenditure and net exports — the formula being GDP = consumption + investment + government expenditure + exports - imports. A closer look at these components will give a fair idea of the bright spots and the areas which are still struggling to rear their heads.

In a developing economy, usually the consumption component of GDP is relatively large. It is not difficult to understand why it is so. When the income of households is small, a large part of it goes into consumption-related items — be it food, education or medical expenses. The remaining portion that is saved — if the financial intermediation is robust — comes back as ‘investments’ or gets taxed by the government.

India, which is a developing economy, has largely been a consumption-driven economy. About 58 per cent of its GDP, as measured by the expenditure method, comprises consumption expenditure. Investments, which are essentially capital investments, account for 27 per cent. These two components together constitute 85 per cent of GDP, making them crucial drivers for the Indian economic growth.

‘King’ Consumer

Usually, as the income level of an economy rises, the consumption component reduces, thanks to a fall in the marginal propensity to consume. For instance, expenditure on items such as food plateaus after a point.

However, the last five years have been an anomaly. The share of consumption expenditure in the Indian economy has improved while that of investments fell. The share of investments fell from 36 per cent (September ’11) to current levels of 27 per cent. During the period, consumption inched up by 3 percentage points to 58 per cent of GDP. So, which areas within consumption have shown a growth over the last few years? To answer this question, we looked at a handful of indicators that capture trends in consumption — from consumer confidence index, IIP figures to automobile sales and monsoon data.

Green shoots

The good news is that not only is the structural trend up for consumption, but this theme has performed well in the short term as well. Eight out of 10 consumption-based indicators show an uptick in growth figures since December levels.

More confidence

ZyFin Advisors’ Consumer Confidence Index (CCI), which tracks the sentiment among household consumers, was up at 47.8 in April ’16 as compared to 46.9 in December ’15. Two years back (April ’14) it was way lower at 40.6. While over the short term, urban consumers are more confident, even the structural trend is upwards. However, with its index value being below 50, it also indicates that the majority of consumers think that conditions are not improving materially.

Continuing demand for consumer credit also shows that Indian consumers, especially the urban lot, are continuing to buy consumer goods.

Vroom-Vroom

Auto producers have made the most of the growing demand from urban India by showing strong growth in the recent past. This trend was maintained in 2016 with passenger car sales growth moving up to 5.2 per cent in July 2016, up from 4.6 per cent in December 2015.

Rural consumption figures, which hit the speed-breaker after bouts of poor monsoon in 2014 and 2015, are now showing signs of pick-up.

The motorcycle sales data, which essentially is driven by rural demand, is up 5 per cent on y-o-y basis in July ’16 as compared to December ’15, when it posted negative growth of 6 per cent.

Not durable

Analysis of the IIP (Index of Industrial Production) figures relating to consumer goods, however, throws up mixed trends. Overall IIP for consumer goods grew at a slower 2.8 per cent in the month of June 2016 compared to 3.2 per cent in December. And on bifurcation of the above category into consumer durables and non-durables, we find that it is the consumer durables which played spoilsport this calendar.

Consumer durables’ output grew 5.6 per cent in June 2016 compared to 16.6 per cent in December 2015. It is best to wait for additional data points before concluding about a slowdown in this area as the structural trend in consumer durables is quite strong and points northward.

Interestingly, IIP (non-durables) while managing to grow relatively faster in recent times, also posted a lower growth figure (1 per cent). Two years back, it grew at a relatively faster clip of 1.9 per cent. The slowing rural demand has taken a severe toll on this sector.

Takeaways

Improving consumer sentiment as well as pick-up in sales of cars, motorcycles and tractors indicates that rural and urban consumer demand is robust.

This theme is likely to gain traction in the coming quarters with the disbursement of pay, pension and arrears following implementation of the 7th Pay Commission awards.

This can provide a kicker to consumer durables, automobiles and other consumer discretionary spends.

The structural uptrend in IIP for durables production, coupled with the higher growth rate, shows that the structural trend is still on the way up. Producers are still anticipating robust consumer demand for their products.

And with 80 per cent of the country receiving normal to excess rainfall this year, along with cumulative rainfall being 3 per cent over its long-term average, rural consumption is likely to pick up next year.

Equity investors, especially conservative investors, could continue to bet on the consumption theme through stocks of auto and auto component manufacturers and consumer durables makers available at reasonable valuations.

Investment

The Investment component, while a relatively smaller component of the GDP, also has close linkages with the rest of the economy.

Green shoots

It is not entirely upbeat in the investment segment. While green shoots are visible in some pockets, some areas are still struggling. Eleven out of 20 investment-based indicators showed uptick in growth figures since December levels.

Mixed Core

And among the core sectors, production growth (y-o-y) is higher in coal, steel, cement and electricity generation in June 2016 compared to December 2015. What is noteworthy is the fact that for the steel sector, the growth in production has moved from the negative to the positive territory which, to a large extent, has been helped by protectionist government policies in recent times.

While higher coal production is good for Coal India and for user industries, higher power generation does not spell good news for power producers. This is because the poor financial state of State Electricity Boards dampens their purchasing capacity. This results in the excess power being sold at lower rates in the spot market.

Crude petroleum and natural gas, hit by structural bottlenecks, too, continued with their negative growth trend. Growth in fertiliser production was also lower than the growth witnessed in December 2015 of 13.1 per cent, as against 9.8 per cent in July 2016.

Manufacturing Up

The Nikkei PMI (Purchasing Managers Index) figures are up on an overall basis this year. Interestingly, Nikkei PMI manufacturing moved up from the below 50 threshold to above 50 — indicating that more manufacturers are now bullish. Also, the IIP figures for manufacturing are up for the year. So, some green shoots in manufacturing activity are beginning to show up.

However, the RBI’s Order Books, Inventories and Capacity Utilisation Survey (OBICUS) for March ‘16 quarter hints at lower capacity utilisation at 74.1 per cent. With facilities going underutilised due to lower demand, companies are unlikely to spend on capacity expansion, thus delivering a setback to overall capital investment. The survey shows, however, that there is a pick-up in new orders.

Capital goods

With industries postponing their investments, the capital goods sector has been in a slump in the recent past with the IIP capital goods index reporting a contraction for eight months in a row.

It, however, needs to be noted that one item, insulated rubber cables, where the orders are usually lumpy, pulled the overall IIP-capital goods growth figures on the negative side this year.

Weighing heavy

In the auto sector, there is a pick-up in LCV (light commercial vehicles) sales during the year. LCV sales growth climbed 6.3 in July ’16 compared to 5.6 per cent in December ’15.

However, commercial vehicle sales figures slowed down on an overall basis after a sharp pick-up in the first four months of 2016, thanks to slower growth witnessed in MHCV (medium and heavy commercial vehicles). After growing at a rapid clip — upwards of 28 per cent on y-o-y basis in the first four months of 2016 — it hit the speed breaker, growing at a negative 7.6 per cent in July ‘16.

Services

Services is showing a more promising trend than manufacturing. The Nikkei Purchasing Managers’ Index (Services) was at 51.9 in July ’16. Sharp acceleration in new business has provided growth momentum for the service sector, which is also the largest section of our economy. Railways, port traffic, increase in arrivals of foreign tourists and improved domestic air traffic, are providing the necessary growth momentum for this sector.

However, the PMI figures were lower in July ’16 as compared to the beginning of the year.

Takeaways

While private investment is likely to be sluggish, government’s infrastructure spends in roads and railways could be leading to higher production in the core industries of steel, cement and coal.

Some green shoots are visible here and investors can start looking at cyclical stocks in these sectors. However, a bottom-up approach should be adopted since many sectors such as power and real estate are still laden with high debt and grappling with regulatory issues.

Capital goods manufacturers that make products related to construction, logistics, etc., could also see higher order inflow. Services theme, which is allied with urban consumption, is also a verdant area with stocks of tour operators, aviation companies, media, healthcare, hospitality, etc., expected to do well; especially given the favourable demographics in the country.

Financial services, especially micro-finance companies and companies catering to retail segment will also be worth looking at, given the higher demand for credit.

Bird’s eye view

The OECD composite leading India index, which tracks green shoots in the economy, is up for the year. It was at 8.1 in March ’16, against 7.9 in December ’15. The ZyFin Business cycle indicator, which tracks the state of the business cycle in the Indian economy, indicates it is slightly down during the year but the structural trend is on the way up.

However, the external sector looks vulnerable at this juncture, even though there are signs of green shoots in the domestic economy. The current account balance to GDP is almost at similar levels of 1.1 per cent of GDP — and over the last two years has come down from 1.7 per cent.

Exports growth has been negative for 19 of the last 20 months. For imports, it is worse, with 20 of the 20 months witnessing negative growth. Some sectors, however, such as chemicals, marine products, handicraft, plastic and electronic and engineering goods are showing signs of revival. The import bill was lower due to lower crude oil and gold prices. Imports were also lower for coal, fertiliser, ores, iron and steel and machinery and transport equipment.

(With inputs from Seetharaman R)

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