India is on the cusp of an upswing in the business cycle

Apart from the stock market, animal spirits will also be stirred by the government’s business-friendly initiatives, such as the relaxation in labour laws.

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The IMF says India’s potential medium-term real GDP growth is a modest 6 percent per annum. In fact, the IMF’s latest projections for India show growth decelerating from 8.5 percent in 2022-23 to 6.6 percent in 2023-24 to 6.3 percent the following year and to 6.1 percent by 2026-27. True, these projections are to be taken with large doses of salt, but what are the reasons for their pessimism?

The answer lies in the IMF’s Staff Report on India, which says, ‘Potential growth is expected at around 6 percent over the medium term, reflecting a more persistent impact from the pandemic and the need to further strengthen the financial sector. Investment fell sharply and the lagged impact of the pandemic on corporate and financial sectors will likely contribute to lower investment and capital accumulation, including in MSMEs.’

That is in direct opposition to a spate of sell-side reports that paint a picture of steady growth ahead. This is not merely a story of a sharp, short rebound from covid-related restrictions, led by pent-up consumption. Instead, these reports argue that India is on the cusp of an upswing in the business cycle. The title of a Julius Baer report-- ‘India: A Structural Growth Story’-- pretty much reflects the mood on the Street.

The key is a revival of investment demand. And it’s not just brokerages that are predicting this---rating agency Crisil is in the same camp. Jefferies has said India is on the cusp of another boom, like we had in 2003-10. Crisil too says the new capex cycle will be like the one seen in the first decade of the century.

Morgan Stanley has said, ‘This is a clear inflection in India’s macro environment. Rising capex ratios will significantly lift employment prospects and boost income and consumption growth, creating a virtuous cycle.’

The IMF doesn’t agree. According to its projections, total investment as a percentage of GDP is expected to slowly move up from 29.7 percent in 2021-22 to 31.3 percent by 2026-27. That’s way below the 39.7 percent of GDP reached back in 2011-12. Indeed, it’s even less than the 32.8 percent it was as long ago as 2004.

But there are cogent reasons for optimism. As these pages have pointed out earlier, the twin balance sheet problem weighing on the Indian economy has been largely lifted. Both corporate and bank balance sheets are now in far better shape than before the pandemic. Ditto for NBFC and real estate balance sheets. Even government finances have been doing much better than expected this fiscal year. That means the supply side is more robust that it has been in years.

Government policies, ranging from the Production-Linked Incentive schemes to higher import tariffs to setting up a bad bank will also help.

The external environment too is conducive to India’s growth. After many years, we have seen a spurt in exports. The crackdown on companies in China may send capital towards India. India’s foreign exchange reserves are at all-time highs.

There’s also an urgent need for investment in green technologies. A report by Credit Suisse points out that the investment requirements of energy transition will need capacity addition in many areas such as renewable generation capacity, storage, electrification of transport and hydrogen production. Several large corporates have already announced sizable investment plans in renewables.

Interest rates are the lowest in over a decade. Recall that the boom of the 2004-08 period was preceded by a sharp fall in interest rates from the double digits in the nineties. Corporate profitability is much improved.

CMIE data show that Return on Capital Employed for non-financial listed firms in the March 2021 quarter was the highest since the March 2011 quarter. The same goes for interest cover.

And then, don’t forget the stock market. Companies are raising humongous amounts of capital from the market. True, much of it is cashing out by earlier investors, but there’s also plenty left over for spending. Nor should we look merely at the public markets. Billions are flowing into private equity and into start-ups, adding to consumption demand.

More importantly, the rise in the stock market and the wealth effect it produces is an important marker of ‘animal spirits’. As the economist John Maynard Keynes pointed out, ‘“Most probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits — of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”

Apart from the stock market, animal spirits will also be stirred by the government’s business-friendly initiatives, such as the relaxation in labour laws. Monetizing government assets and privatisation will increase the avenues for capital accumulation for private businesses.

The only unknown is the extent of weakness in household balance sheets. Reports indicate, for example, that demand for work under the rural employment programme continues to be higher than in 2019.

Consumer firms have warned of a slowdown in rural demand. CMIE data show that the number of employed persons in September 2021 was less than in October 2016 and the employment rate is much lower.

On the other hand, there are almost daily reports of a spurt in jobs in the tech sector and in the unicorns. Whether the strength of the upper arm of the K-shaped recovery will be enough to offset the weakness in the lower arm remains to be seen.

The IMF too hasn’t cast its assessment of India’s potential growth in stone. Instead, it offers a recipe to improve India’s potential growth. It says, ‘Steadfast implementation of announced structural reforms and further efforts to broaden them are needed. Reduction in tariffs, especially on intermediate goods, and further investment liberalisation can foster India’s integration into global value chains and maximise India’s growth potential.’