Indian economy: From liberalization of 1991 to Pandemic of 2021
In this two part series blog on Indian economy, the first part is devoted to the economic journey from 1991 to 2021.
Indian economy has come a long way since the days of liberalization in 1991. India had barely foreign reserves to cover two weeks of imports, Inflation was at a peak of 16.7 % in August 1991 and fiscal deficit was more than 8%. During that period the then finance minister Dr. Manmohan Singh introduced reforms which opened India to the world and thus started one of the biggest makeover of any country in the world — from a socialist country to a partial capitalist country.
Now in 2021 India has record foreign currency reserves. According to RBI Governor latest statement on June 5th 2021 the reserves are around $600 Billion. Indian GDP increased from $266 Billion in 1990–91 to around $2.9 Trillion in 2021.
I have divided the last 30 years into seven different periods:
a. 1992–1997: Robust growth, High Inflation and Underperforming Equity Markets
The years leading up to the Asian Financial Crisis in 1997 witnessed growth averaging 6.5%. Nevertheless, both Whole Sale Price Index (WPI) and Consumer Price Index (CPI) remained high and averaged at 7.7% and 9%, respectively. Savings and investments as a percentage of GDP rose with the rise in investments being faster than savings leading to a widening current account deficit. The currency suffered and was down almost 30% during the period and bond yields rose to highs. Corporate India delivered good earnings growth, but the Indian stocks delivered subpar returns, underperforming emerging markets (EM) significantly. Consumer staples was the best-performing sector.
b. 1998 -2003: Macro indicators improved and markets outperform on a relative basis
These years were characterized by a healing of the macro balance sheet. During this period, macro indicators improved with inflation moderating around 4–5% but this improvement was accompanied by lower GDP growth (average of 5.2%). RBI kept Real rates high, especially relative to real GDP growth, leading to weak confidence among corporates for fresh investment. This resulted in a slower rise in investment to GDP compared to savings to GDP. By this time the world investors had started looking at India. The term BRIC coined by Goldman Sachs economist Jim O’Neill in his report Building Better Global Economic BRICs put India the “I” in the acronym firmly in the radar of the investors. Brazil, Russia and China being the other three members of BRIC.
The development in the macro parameters set the stage for higher growth rates in the subsequent five years and thus, India’s outperformance vs. the EM.Despite poor earnings, Indian stocks did not fare poorly on a relative basis, although they were down on an absolute basis. Indian equities traded at a discount to EM, ROE was fairly stable due to improving asset turn, corporate balance sheets de-levered and falling yields set the stage for the next bull market. The period was marked by Financials as leading performer across sectors.
c. 2003–2008 : Global liquidity splash helping India becoming a top performing market
The period between 2003 and 2008 saw an increase in growth, stable inflation, and improvement in the productivity dynamic with a rise in investment to GDP. The higher investment did not lead to a widening current account deficit as the rise in savings was led by improvement in public saving (fiscal consolidation) and private corporate saving. The improvement in domestic fundamentals was accompanied by benign global conditions marked by an increase in capital flows, which helped to keep rates low, fund the current account deficit and accrue to FX reserves. Thus, the synchronous recovery in domestic demand and global growth lifted capacity utilization levels, thereby building corporate confidence to take capital spending up. This led to the largest and longest private sector capex cycle in the history of India, taking the share of private capex to 17.3% of GDP in 2008 from a low of 4.9% of GDP in 2001.
What this marked was also the rise in equity and debt issuance. During 2003–08, earnings increased at an average annual rate of 25%. ROE hit record levels and averaged over 20% during this period (the highest ever). Indian equities re-rated significantly compared to EM. The five-year period also witnessed significant purchases by foreign investors (US$47 billion). Indian equity markets delivered a CAGR in returns of 44%, beating EM in USD terms by nearly 90% with industrials the best-performing sector.
d. 2008–2013: Macro and Micro Misallocation
This phase was marked by moderate growth driven by poor macro policies, particularly loose fiscal and monetary policies driven by populist political decisions such as farm loan waiver. This weakened investor sentiment.The fiscal deficit doubled to 9.9% of GDP between F2008 and F2009 while investment to GDP declined from 38.1% to 34.3% in the same time period. This unproductive growth mix manifested itself in the form of high and persistent inflation, which averaged 10% during this time period, an unprecedented period of high rates of inflation in India’s economic history.
The global financial crisis in 2008–09 compounded problems for India. Along with a challenging macro, overcapitalized balance sheets combined with high leverage hurt Corporate India deeply. Asset turnover fell and so did margins; consequently, India’s ROE premium to EM fell to all-time lows. Bad macro and micro led to Indian equities delivering 0% returns and underperforming EM by 29% between 2008 and 2013. This performance vs. EM was even worse than the underperformance between 1994 and 1997. The search for quality was reflected in outperformance in sectors like Healthcare and Staples.
e. 2013 -2015: Change of Government restored confidence and stabilized macro parameters
External factors often triggered a growth shock in EM including India.The high rates of inflation that had prevailed and the slow pace of monetary tightening meant that real rates were kept low on both an absolute basis and relative to the US. In that context, India was one of the more affected economies during the taper tantrum episode as its current account deficit (tracking at 6.8% of GDP in Dec-12) and also the low level of real rates meant that it had to tighten monetary policy to deal with a change in the monetary policy stance in the US. Even though policy makers moved to take measures and lower the fiscal deficit, the starting point of fiscal deficit was still elevated at 6.9% of GDP in F2013. The combination of pro-cyclical monetary and fiscal tightening therefore marked the start of the adjustment phase. With these measures, current account balances improved and inflation moved toward more normalised levels. Thereafter, the macro risk premium reduced.
However, these corrective measures also had a negative impact on the economy. Domestic demand weakened with both consumption and investment slowing. Indeed, consumer durables production declined between 2013 and mid-2015, and investments (private projects under implementation) too contracted. Inflation had eased significantly to an average of 5.6% in the 2nd half of 2014, real rates were built up and the external stability metric of current account balance improved from -6.2% of GDP in Dec-12 to -1.5% of GDP by Dec-14. Markets gained confidence in the recovery and an absolute majority gained by the National Democratic Alliance in the 2014 general elections. Indian equities re-rated significantly and were up 20% during this period, thereby outperforming EM by 37% even as earnings growth remained weak at 0.4%.
f. 2015–20 (COVID disruption): Gradual Recovery Interrupted by Exogenous Shocks
As macro-stability indicators improved, central banks began to normalise monetary policy, supporting a slow recovery. Productivity also improved and the economy gradually returned to a sustainable growth path. India entered the gradual recovery phase from 2015, as growth recovered slowly and macro stability indicators improved. This was also reflected in significant improve- ment in FDI flows, which continue to see sustained pickup and reached near all-time highs of 3.2% of GDP. Growth recovery between 2015–17 was held back by exogenous factors, including weaker export income (commodity price disinflation) hurting corporate revenues growth, and thereafter, by the demonetization and implementation of GST, which created short-term domestic disruptions and prolonged the growth recovery.
In 2018, the external environment become more challenging with rising oil prices, tighter global liquidity conditions and rising US-China trade tensions coupled with rising risk aversion in the domestic lending sector following default by a large non-bank finance company This again kept domestic and external demand weak. The slow- down in domestic demand continued into 2019 mainly due to a risk averse corporate and financial sector and weak consumer sentiment. The government responded with a large reduction in corporate tax rates in Sep. 2019, which improved sentiment and provided leeway for corporate sector balance sheets to improve. Even as growth data started to show early signs of improvement in January-February 2020, conditions changed quickly with the COVID-19 pandemic. India entered into strict nationwide lockdown conditions in the initial months of the year in a bid to contain the spread of the pandemic and minimise disruptions, which led to a record contraction in GDP in Quarter ending June.
Corporate India also witnessed its longest earnings recession in its history. Given the starting point of valuations of 24x, market returns hurt. The equity market had delivered 4.9% CAGR in returns from 2015 to March 2020, marginally underperforming EM equities by about 0.4%. The average earnings growth remained weak at -2.5%. Technology was the best-performing sector during this period underpinning a period where defensives and quality businesses delivered both earnings and performance. The silver lining amidst the delay in earnings recovery and the market underperformance has been the emergence of the domestic liquidity story. From Jan-15 to Jun-20, equity mutual funds received equity inflows of about US$113bn, including ETFs. That said, even this story has been through a downturn over the past 8 months with net out flows of US$7 billion, which started during the pandemic and has continued.
g. Mid 2020 to present:
Beginning from May/June 2020 the stringent lockdown conditions were gradually eased as per the phased reopening guidelines, in order to facilitate gradual normalisation of economic activity. While the initial uptick in high frequency indictors such as power, auto sales, PMI, GST Collections, and E-Way Bills was attributed to pentup demand followed by heightened demand due to the festive season, the positive growth momentum in YoY terms has sustained over the months, thus reflecting a V-shaped recovery. Manufacturing PMI has remained in the expansionary zone for seven consecutive months while revenues from GST collections have tracked above the Rs1tn (1 Lakh Crore)mark for 5 months in a row, recording an all- time high of Rs1.2tn in January 2021. The continued improvement in high frequency and forward indicators, supported by a favourable monetary & fiscal policy framework coupled with recovering domestic & external demand conditions, thus bodes well for the short- and medium-term growth outlook.
The stock market hit a multi-year low point of valuations at the end of March 2020, with the trailing P/B at 1.7x and market cap/GDP at 49% — close to new lows for the millennium. The earnings drawn down for the MSCI India index was 30% whereas the Sensex fell 38% to its trough at the end of March 2020. From there the market registered a swift recovery and has almost doubled from the trough, not very different from the rest of the world. Among the three domestic factors that helped the recovery in share prices was the strong policy action from the government target at reviving private corporate profits, better than expected management of the pandemic resulting in less than the global average case fatality rate and strong corporate action through the pandemic including M&A and other investments and cost cutting initiatives.
This recovery got a big hit with the catastrophic second wave hitting India in April 2021 which is not yet over. The impact of which remains to be seen.
In the next blog I would highlight things which would be a catalyst for growth in 2nd half of 2021 and 2022.
