India’s economic prospects are looking up

After the?Nifty 50?came within touching distance of 20,000, the benchmark index is moving sideways above the 19,000 mark. Mid- and small-cap stocks were part of the larger rally in stocks over the past few months. With the market taking a breather before climbing to new highs, the market seems to be digesting company earnings, economic data, and global factors.

We decided to take a look at some of the economic data that came out over the past 7-10 days to read the tea leaves to figure out what might come next.

Let’s get into it.

The sweet spot

Standard Chartered Bank (StanChart) in a report recently said that apart from the weakness in global growth, there is nothing that is holding back India’s march towards an upper middle-income country. Consequently, equities will do well as India hurtles towards $4,000 per capita income over the next 7 years.

Additionally, StanChart said the corporate profits-to-GDP ratio at the end of FY23 came in at 4.1%, which is lower than the 4.3% in FY22. Morgan Stanley believes that this ratio will rise to 8% over the next 4-5 years.

The Centre’s?production-linked incentive scheme?for manufacturing, and the cut in corporate taxes in 2019 for new manufacturing entities could lead to a surge in manufacturing activities. This is mainly due to the structural changes in the global supply chains as multinational corporations try to diversify their sourcing away from China.

If this thesis plays out, the only way is up for equity markets and income levels over the rest of this decade.

Inflation’s Jekyll and Hyde act

In 2022, India’s wholesale price inflation (inflation at factory gates) or WPI was higher than consumer price inflation or CPI (retail inflation). Essentially, companies and businesses were paying higher prices for inputs and supplies but weren’t able to pass it on to their end customers. This was because there was a fear that this could hurt nascent greenshoots of demand after the devastation caused by the pandemic to economies globally

In 2023, the tables have turned and how.

WPI has been in the negative territory since April, and retail inflation spiked due to rampant inflation in food prices, mainly due to spike in vegetable, pulses, spices and cereal prices. From the face of it, this means that businesses have got their pricing power back. But because consumption expenditure contributes to around 60% of India’s GDP, runaway CPI or retail inflation could scuttle a sustained growth in India’s economy.

The Reserve Bank of India (RBI) believes that inflation will stay above 6% during Q2FY24, which justifies its continued pause on rate hikes in its August monetary policy announcement. ?Inflation spiked to a 15-month high of 7.44% in July 2023 after the policy was announced, after staying below 5% from April-June 2023. Many believe this might just be a seasonal spike due to food prices as core inflation (excluding fuel and food) is just slightly above 5%.

This probably means there is no rate cut coming in FY24 as the RBI’s Monetary Policy Committee tries to anchor retail inflation to near 4%.

PMI sustains the hope

Although India’s growth in industrial production denoted by index of industrial production or IIP dipped in June 2023 to 3.7%, there is enough evidence that industrial activity is picking up. The March 2023 IIP growth number was a shocker at 1.7%, but there was recovery in April-June.

Also, the purchasing managers’ index or PMI for both manufacturing and services is showing decent activity. A PMI number of above 50 indicates growth. A cursory look at the PMI number shows that the services sector is on a roll, and manufacturing has to catch up with it.

As economy watchers wait for the last day of August for the GDP numbers for Q1FY24, the RBI expects growth to come in at 8%. This probably explains the exuberant enthusiasm among investors and market participants about India’s growth prospects. And we haven’t even entered into the festive season yet. That will give its own boost to the economy.

The hope is that runaway retail inflation doesn’t hurt demand so much that consumption expenditure is knocked back.