Forbes India 15th Anniversary Special

Unfair to judge private capex because it's still at very early stages of recovery: Morgan Stanley

Here's why Morgan Stanley's chief India economist, Upasana Chachra, believes domestic growth is on track despite risks of extreme weather conditions and global headwinds

Neha Bothra
Published: Sep 12, 2023 03:23:34 PM IST
Updated: Sep 12, 2023 03:36:58 PM IST

Unfair to judge private capex because it's still at very early stages of recovery: Morgan StanleyA key factor for us and our framework is that we expect the investment rate to pick up, driven both by public and private, and of course, as we go forward, more by private sector investments.  Image: Salman Ali/Hindustan Times via Getty Images

The recently concluded G20 New Delhi Summit put the spotlight on India as Asia’s growth engine. The world’s fastest growing major economy aims to become the third largest global economy by FY28. The world’s most populous country is seen as a vibrant and booming consumer market. But what are the speed bumps? In a wide-ranging conversation, Upasana Chachra, chief India economist, Morgan Stanley says, “Private capex is where the big concern or the scepticism always lies because private capex has languished in the last many years in the country.” But Chachra believes the private capex cycle has turned and expects it to strengthen in the coming quarters.

Edited excerpts:

Q. What do you make of the June GDP numbers and do you expect growth to taper in the coming quarters?
Yes, but I wouldn’t contextualise that as a slowdown because the q-o-q growth momentum would be stronger in the second half [as per our estimates]. The base-effect related issues are still lingering. We generally do see the first half being sequentially a bit weaker. In the second half momentum picks up. The December quarter has a lot of festivals, wedding season, and activity tends to pick up. The last quarter also tends to have more activity in terms of credit growth and exports. If you look at GDP and other high frequency data points, you would get the picture that the economy is on the right path.

Of course, this is still an early stage of the recovery after the pandemic. Therefore, I think there will be some bumps. Some aspects of consumer demand have lagged. But I think that is a part and parcel of the early stages of the economic recovery. As this growth recovery gets more entrenched, we will see more broad-based improvement in the numbers across consumption and capex. That's what finally happens when you get a virtuous cycle of growth. So, we think that growth is on track to remain above 6 percent in y-o-y terms for both FY24 (6.4 percent) and FY25 (6.5 percent).  

Q. The rural economy is not out of the woods. We are not very sure about how El Nino will affect crop prices but it puts a question mark on how festive demand will play out. To what extent will this weigh on growth?
Fair enough. We have been seeing this issue that rural demand or lower income segment consumption demand had been lagging and the urban demand or the richer income or premium segments have been doing better. Having said that, if we look at the rural high-frequency tracker, we are seeing that it has been improving at a slow pace. So, it’s not in the accelerated phase. But nevertheless, it has not deteriorated as well. So, of course, El Nino and weather-related disruptions remain a risk to rural recovery. I wouldn't take that away. That is something we need to be watchful for.
At the same time, I think there are certain tailwinds to rural demand. One will be improving terms of trade because non-commodity or non-food inflation has been moderating. Two, the focus of the government on ensuring better supply-side management of food/fuel-related inflation risks. So that also benefits the outlook for rural demand, because inflation can hurt rural more. So that will also negate some of the risks. And lastly, the government will continue to ensure that money flows into the overall economy, especially through the capex route. So that will also have its trickle-down impact on the rural economy.

We are already seeing that capex spending, both by the Centre and states, has been front-loaded in the June quarter. So that has grown at very high double-digit levels for both Centre and states. That is getting reflected in all the construction-related indicators like cement, steel demand and also like the construction GDP numbers. That will be a positive factor for rural demand because construction-related jobs have the highest employment elasticity. And that will also create its own cycle of improving rural incomes, and therefore, demand. So, I think, it is a case where I would be cautiously optimistic on rural demand, and I would think that the divergence between urban and rural should narrow towards the end of this fiscal year.

Also read: Why the rural economy isn't out of the woods yet

Q. The private capex cycle hasn't picked up meaningfully. Can that change the growth picture?
When we say we are constructive on India, a key factor for us and our framework is that we expect the investment rate to pick up, driven both by public and private, and of course, as we go forward, more by private sector investments. So, if we now look at high-frequency or coincident data points related to capex, I wouldn’t say that it’s a discouraging picture. There are certain green shoots that are emerging. Public capex is doing its fair share of pushing the capex line item higher and that is having some multiplier effect into other indicators as well e.g., cement, steel demand, or other infrastructure construction-related indicators. Private capex is where the big concern or the scepticism always lies because private capex has languished in the last many years in the country.   
But what we are seeing, from a high-frequency data point, are nascent signs of improvement in private capex. So, for the June quarter, if you look at private sector new investments, we tend to look at this on a four-quarter trailing basis, because these numbers can be lumpy on a one-quarter basis. So, the four-quarter trailing trend has been improving for last few quarters and currently tracking at nearly all-time highs. This is nominal, but even if we deflate it for the inflation aspect, then also we see that this is tracking at nearly the highest since 2010. So, there is a pick-up in private capex that is happening—of course it’s at very early stages of recovery. It has to get more broad-based and more entrenched.

But we do think that all the conditions are in place for that to happen. If you see the private sector balance sheets of the corporate sector, corporate debt-to-GDP is at a 16-year low, so balance sheets are in pristine position. Similarly, for the financial sector, banks’ impaired loans are tracking at 11-to-12-year lows. Again, their ability to fund and willingness to lend, is high and those are very important cyclical factors which will help improve this capex trend. But yes, there are concerns on the longevity or the sustainability of the [private capex] cycle. I think cyclical and structural factors that are coming together will ensure that this cycle continues.
We run a fiscal deficit both at the central government and the state government level. So of course, the government is doing [its bit] in terms of changing the mix of the spending and that is what has actually driven some of this rise in capex as well. But the bulk of the heavy lifting finally, as investment rate needs to pick up, has to come from the private sector side. The cycle generally happens and sustains for at least 5 to 7 years, and that’s how the private capex investments would also come in. So, at the moment, I think it will be unfair to judge private capex recovery or the pace of it, because it is still very early stages of recovery.

Just to give you context, in the last 10 years, that is the 2010-decade, capex-to-GDP kept declining. So, capex-to-GDP probably peaked around 37-38 percent of GDP around the beginning of the decade, and it went down to as low as below 30 percent when we were in the pandemic. So, that was the trough. That is the extent of investment degrowth, in a way, that we have seen in the economy. And that was driven by the twin-balance-sheet issues. So that period was a period of painful adjustment [at both the macro and micro level]. That is now behind us. And that is what makes us also constructive on India’s growth outlook. Now the starting points are very favourable.

Q. Coming to inflation, what’s your outlook for the coming months after the shocker last month. Food inflation has been a concern. Wheat and rice prices have been inching up.

Yes, inflation has surprised on the upside in July quite meaningfully. If we look at the tracking numbers, inflation has likely peaked with the July number (7.4 percent), in our view, and will moderate, but the moderation will get more visible from the September prints. So, vegetable prices, disinflation will get reflected in the August print to some extent, but not fully. So, we are still tracking the August CPI number at close to 7 percent from 7.4 percent. But the September CPI number, we think, will be closer to 6 percent, depending on how the food inflation finally pans out this month and thereafter below 6 percent. I think food inflation will probably continue to bother us a bit for some time. But having said that, I think the government also probably understands this and, therefore, has been pre-emptively taking measures to ensure that these do not flare up and cause any second-round problems.

Also read: 'Uncertain world economy puts limitations on our growth': Sanjeev Sanyal

Q. What do you think would be the key challenges for India at this point and how should it manage those risks?
I think from a cyclical perspective most of the challenges are global in nature. So, it will be, I think, in the very near term, if you have to think from a 12-month perspective, the trend in global growth, the trend in global financial conditions and commodity prices, I think those would be important factors that can impact India's cyclical growth momentum. So, any adverse changes in global growth, or greater than expected tightening in global financial conditions, can impact capital flows and therefore the financial conditions domestically as well. Similarly, very sharp changes in commodity prices can still expose the economy to some of these macro stability risks. So, those I would say, are the near-term challenges from a very near-term cyclical growth trend perspective. From a domestic perspective, in the near-term, a big event risk to watch out for would be elections, how they pan out. And that is important from a policy continuity and reform momentum perspective as well. So, I think that remains a key event risk to watch for in the near term.
From a structural perspective, I think, the challenges or the concerns for India that we should probably be looking out for, would also be I think on the labour side. So, while a young demographic is a favourable factor for India, we need to also focus on the skilling, and ensure that there is not a big supply-demand mismatch in the labour and the sort of jobs that are being created, because things are moving very fast. More can be done by the government around labour laws which can probably be streamlined. Some progress has been made, but a lot more can be done again on land.