In Focus: India For private circulation only

India: Analysing implications of low nominal GDP growth 

Nominal GDP growth has witnessed downward pressure in recent years, in line with the declining inflation trends.

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According to our analysis, we believe that ~75% of the GDP basket is deflated using WPI vis-à-vis CPI, nominal GDP has slipped below real growth in Q2 FY2016 on the back of negative WPI trends.

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With WPI likely to remain low on subdued global commodity prices, we expect the downward pressure on nominal GDP growth to continue in the coming quarters

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Commodity prices usually witness multiyear price cycles. We believe given the conjunction of demand-supply fundamentals for most commodities including oil and metals, strength in Dollar and slowdown in global demand will keep commodity prices suppressed in the medium term.

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The trend in nominal GDP is downward, which is on expected lines given that price levels have sharply fallen. Since, the creation of base money in the system to support the demand for money is a direct function of nominal GDP growth hence it is possible that growth rate in RBI’s balance sheet expansion may also remain muted.

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Credit & deposit growth: Fall in nominal GDP growth is likely to continue to weigh on nominal variables such as bank deposit and credit growth

December 16, 2015

Kamalika das [email protected]

a.

+91-22- 26536280

Kanika Pasricha

Despite the rise in real rates, deposit growth has slipped to near record low levels of 10.4% YoY on fall in nominal growth

b. Credit growth has persisted at sub-10% YoY levels consistently since May-2015, on fall in nominal growth along with adverse impact of fall in commodity prices on credit growth

[email protected]

+91-22- 26537243

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Corporate revenues: The fall in nominal GDP or activity is also likely to keep corporate revenues muted. This is likely to impact corporate balance sheets given that operating income is under pressure but interest cost remains elevated.

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Fiscal implications: On the fiscal side there would be a short term and a long term impact. a.

Please see important [email protected] disclaimer at the end of this report

Lower nominal GDP leads to lower tax growth and will also affect the target fiscal deficit as % of GDP.

b. In the medium term, the debt sustainability metric of (r-g) would also need to be monitored. To conclude, we note that the negative spread between nominal and real GDP growth is attributable primarily to the GDP deflator, which has fallen sharply because of contraction in the WPI. Going ahead, once the global commodity prices witness a reversal in trend, we

believe that this spread is likely to correct in the coming years and is unlikely to be a structural shift. However, the more noteworthy trend is the fact that nominal GDP growth has slowed down as compared to double digit levels witnessed earlier. Also, it is likely that the growth may remain muted given subdued price pressures globally. Nominal GDP growth on a declining trend….

…on subdued price pressures in the economy

Price trends during the relevant period

GDP (New base: 2011-12) (% YoY)

FY2013 FY2014 FY2015 Q1 FY2016 Q2 FY2016

(% YoY) FY2013 FY2014 FY2015

Q1 FY2016 Q2 FY2016

Real GDP

5.1

6.9

7.3

7.0

7.4 WPI

7.4

6.0

2.0

-2.3

-4.5

Nominal GDP

13.1

13.6

10.5

8.8

6.0 CPI

10.2

9.9

6.0

5.1

3.9

Source: MOSPI, ICICI Bank Research

Source: MOSPI, ICICI Bank Research

In Focus Nominal GDP growth has slowed down sharply in the current fiscal

While the change in base year has led to a sharp upward revision in real GDP numbers, however, there is a downward trend in nominal GDP growth. As inflation levels are witnessing a declining trend in recent years, this has put downward pressure on nominal GDP growth.

GDP (New base: 2011-12) (% YoY)

FY2013 FY2014 FY2015 Q1 FY2016 Q2 FY2016

Real GDP Nominal GDP

5.1

6.9

7.3

7.0

7.4

13.1

13.6

10.5

8.8

6.0

Source: CEIC, ICICI Bank Research

Given the higher significance of WPI in GDP calculation, nominal GDP has slipped below real growth in Q2 FY2016. Our analysis using GDP manual indicates that ~75% of GDP basket is deflated using WPI vis-à-vis CPI. WPI index has been consistently in the negative territory since November-2014 on the back of subdued global commodity prices.

Price trends during the relevant period (% YoY)

FY2013 FY2014

FY2015

Q1 FY2016 Q2 FY2016

WPI

7.4

6.0

2.0

-2.3

-4.5

CPI

10.2

9.9

6.0

5.1

3.9

Source: CEIC, ICICI Bank Research

With WPI likely to continue to remain low in the coming quarters, we expect the downward pressure on nominal GDP growth to sustain.

Global backdrop for commodity price outlook

We must note that WPI is used more extensively in deflating GDP as compared to CPI. WPI is extensively correlated with global commodity prices given the high import intensity of industrial sector. Global commodity prices will be affected by various factors: Broad based Dollar strength: The Federal Reserve is on track to raise policy rates for the first time in 9 years, which will lead to sharp divergence in monetary policy as compared to other major central banks in the global economy. This is likely to result in considerable strength in the Dollar index thereby weighing on the commodity class, which is primarily denominated in Dollar terms. Slowdown in the Chinese economy: China is one of the world’s largest consumers of energy and metals. However, the country is witnessing s secular slowdown in growth rates and 2016 is likely to witness rates below 7% YoY. Against this backdrop, a significant source of global demand for commodities is likely to take a backseat thereby weighing on prices. Structural slowdown in commodity super cycle: Commodity prices usually witness multiyear price cycles. We believe given the conjunction of demandsupply fundamentals for most commodities including oil and metals, strength in Dollar and slowdown in global demand will keep commodity prices suppressed in the medium term.

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In Focus

Weakness in global commodity prices is weighing on manufactured goods inflation

Source: CEIC, Bloomberg, ICICI Bank research

Implications of slowdown in nominal GDP growth

The latest GDP data indicates that while the real economic activity is on a recovery path, the fall in general price levels in the economy is weighing on nominal growth numbers. This is likely to weigh on nominal variables like bank deposit and credit growth. We note that the new GDP series has some methodological nuances which may have led to a more than expected fall in nominal GDP growth rates. However, what is relevant is that the trend is downward, which is on expected lines given that price levels have sharply fallen. Since, the creation of base money in the system to support the demand for money is also a function of nominal GDP growth hence it is possible that there may not be a sharp increase in the rate of RBI’s balance sheet expansion going ahead. If that is the case then given money multiplier the growth rate in money supply and its components such as deposit and credit are unlikely to see robust improvement over the next few quarters. Reserve Money Money supply Money Multiplier (RHS)

(% YoY) 35

6

30

5

25

4

20

3

15

2

10

FY2015

FY2014

FY2013

FY2012

FY2011

FY2010

0 FY2009

0 FY2008

1 FY2007

5

Source: CEIC, Bloomberg, ICICI Bank research

3

In Focus The relationship between the various nominal variables according to the old GDP is shown below: Nominal GDP

(% YoY) 25

Real GDP

Money supply

20

15 10 5

FY2014

FY2013

FY2012

FY2011

FY2010

FY2009

FY2008

FY2007

FY2006

FY2005

FY2004

FY2003

FY2002

FY2001

FY2000

FY1999

FY1998

0

Source: CEIC, Bloomberg, ICICI Bank research

The illustration shows that there exists a strong correlation between nominal growth trends and money supply growth in the economy. In what follows we will examine the implications of the above backdrop on components of money supply such as deposit and credit growth. Deposit growth at record lows (1) Deposit growth likely to remain weak given slowdown in nominal GDP growth

Deposit

(% YoY) 30.0

Deposit growth plummeted to near record low levels of 10.4% YoY in the latest fortnight. Our analysis indicates that deposit growth is primarily a function of the following factors:

25.0 20.0

15.0

a.

10.0

Nominal GDP growth

b. Real interest rate

Deposit growth

(% YoY, 3m MA)

(pp, 3m MA)

Real return (RHS*)

Oct-15

Oct-14

-10.0

Oct-13

10.0

Oct-12

-5.0

Oct-11

15.0

Oct-10

0.0

Oct-09

20.0

Oct-08

5.0

Oct-07

25.0

Oct-06

10.0

Oct-05

30.0

Oct-04

Nov-1 5

While real rates have increased, which should have supported deposit growth, however the sharp fall in nominal GDP growth has led to an overall decline. This implies that positive real rates is necessary but not sufficient condition for supporting a pickup in deposit growth.

Oct-03

Source: RBI, ICICI Bank Research

Nov-1 3

Nov-1 1

Nov-0 9

Nov-0 7

Nov-0 5

Nov-0 3

Nov-0 1

Nov-9 9

0.0

Oct-02

5.0

*Real return calculated using 1-year deposit rate adjusted for CPI

Source: RBI, MOSPI, ICICI Bank Research

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In Focus

(2) Downward bias to credit growth likely to remain in the rest of the current fiscal Credit growth has also sunk to record lows

Credit growth also remained weak at near record low levels of sub 10% YoY in the latest fortnight. Our analysis indicates that apart from a slowdown in nominal GDP growth, decline in commodity prices is also contributing to downward pressure on credit growth.

Non-food credit

(% YoY) 40.0

Industry credit (ex petroleum) (% YoY)

35.0 30.0

40.0

Global comm odity price^(RHS) (% YoY) 50.0

30.0

25.0

20.0

0.0

10.0

-25.0

0.0

-50.0

25.0 20.0

15.0 10.0 5.0

Source: RBI, ICICI Bank Research

Oct-15

Oct-14

Oct-13

Oct-12

Oct-11

Oct-10

Oct-09

Oct-08

Oct-07

Nov-15

Nov-13

Nov-11

Nov-09

Nov-07

Nov-05

Nov-03

Nov-01

Nov-99

0.0

Source: RBI, Bloomberg, ICICI Bank Research (^using Thomson Reuters’ CRB index)

Given the high import intensity of industrial sector, the sharp fall in global prices has led to a drop in costs and consequently weighed on credit demand.

Sector-wise import intensity* Imported raw S ector material (% of total) Chemicals and products Fertilisers 65 Pesticides 48 Organic chemicals 34 Inorganic chemicals 44 Other chemicals 40 Basic metals, alloys and metal products Iron and steel 43 Non-ferrous metals 87 *using annual report data of top companies in each sector for imported raw material expenses Source: Prowess, ICICI Bank Research

(3) Corporate revenues likely to come under pressure Recent data shows that corporate revenue growth has also been tepid and operating income is in contraction mode. However, we also note that although overall revenues are under pressure but some respite may be there on the input costs front considering the steep fall in commodity prices. This is likely to impact corporate balance sheets given that operating income is under pressure but interest burden remains elevated. GDP (N ew base: 2011-12) (% Y oY ) Nominal GDP

FY 2013 FY 2014 FY 2015 Q1 FY 2016 Q2 FY 2016 13.1

13.6

10.5

8.8

6.0

Total operating income 7.6 Source: Prowess, ICICI Bank Research

5.5

0.3

-4.3

-5.2

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In Focus

(4) Fiscal situation will be adversely affected sustainability issues likely in the medium term

with

debt

In the short term, there would be an impact on the fiscal deficit target. The Government has budgeted 11.5% growth for nominal GDP in FY2016 fiscal calculations. However, recent trends indicate that this may be undershot. If we assume full year nominal GDP growth to be ~9% YoY, then to achieve fiscal deficit target of 3.9% of GDP, the Government would have to cut spending or find resources to the tune of ~INR 200 bn. Apart from this, there is a strong correlation between growth in tax revenues and nominal GDP growth. This may also be adversely affected if nominal growth stays muted.

Strong correlation between nominal growth and tax revenues

(% YoY)

Nominal GDP growth

21.0

Tax revenues (RHS)

(% YoY) 30.0

18.0

Medium term debt sustainability implications: The conventional debt sustainability metric of (r-g) is important to determine the stability of the debt path of an economy. It simply means that for the debt path to be sustainable, the rate at which a country pays interest on its stock of debt should be less than the rate at which it generates income, proxied by nominal GDP growth. Normally, for this to be stable the difference should be negative and preferably widening. In India’s case, in the recent months it has now turned positive, which is a cause for concern and has to be monitored going ahead.

20.0

15.0

10.0 12.0

0.0

9.0

FY20 15

FY20 14

FY20 13

FY20 12

FY20 11

FY20 10

FY20 09

FY20 08

FY20 07

FY20 06

FY20 05

FY20 04

FY20 03

FY20 02

FY20 01

FY20 00

-10.0 FY19 99

6.0

Source: RBI, ICICI Bank Research Source: RBI, ICICI Bank Research

To conclude, we note that the negative spread between nominal and real GDP growth is attributable primarily to the GDP deflator, which has fallen sharply because of contraction in the WPI. Going ahead, once the global commodity

prices witness a reversal in trend, we believe that this spread is likely to correct in the coming years and is unlikely to be a structural shift. However, the more noteworthy trend is the fact that nominal GDP growth has slowed down as compared to double digit levels witnessed earlier. Also, it is likely that the growth may remain muted given subdued price pressures globally.

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In Focus

ICICI Bank: ICICI Bank Towers, Bandra Kurla Complex, Mumbai- 400 051. Phone: (+91-22) 2653-1414 Treasury Research Group Economics Research Sunandan Chaudhuri Kamalika Das Kanika Pasricha Samir Tripathi Niharika Tripathi Sagrika Gogia

Senior Economist Economist Economist Economist Economist Economist

(+91-22) 4008-7525 (+91-22) 4008-1414 (ext 6280) (+91-22) 4008-7243 (+91-22) 4008-7233 (+91-22) 4008-1414 (ext 6943) (+91-22) 4008-1414 (ext 2180)

[email protected] [email protected] [email protected] [email protected] [email protected] [email protected]

Treasury Desks Treasury Sales Gsec Desk Interest Rate Derivatives Corporate Bonds

(+91-22) 2653-1076-80 (+91-22) 2653-1001-05 (+91-22) 2653-1011-15 (+91-22) 2653-7242

Currency Desk FX Derivatives Commodities Desk

(+91-22) 2652-3228-33 (+91-22) 2653-8941/43 (+91-22) 2653-1037-42

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