Wednesday, April 15, 2015

India races ahead as investment cycle begins

It is IMF and World Bank who agree that India will surpass China in the economic growth rate in the coming days.  (Link: Well, the indicators were everywhere. In the last couple of months the following were indicating that India is preparing for its next growth phase.
  • Shrinking deficits, less volatile currency
  • Lower inflation, lower interest rates
  • Rating agencies revising outlook
  • Hiring picked up, lower unemployment
  • Funds inflow, new projects announcements

 It is all good news. But how the growth would distribute across the society?

Wages rise, savers suffer

  • As the stalled projects become functional again, the immediate beneficiary would be labor base and banks. Big infrastructure/construction projects employ low skilled and semi-skilled workers in huge numbers. As the labor absorption increases, wages begin to rise. That pace of expansion would be in double digits.
  • The policy focus such as ‘Make in India’ will increase the demand for high skill labor so the large number of workforce would transition into higher incomes.
  • As the cash flow comes back into stalled projects, Banks will see their dues coming back to them as NPA's reduce. Credit growth makes a comeback and helps the banks fare better.
  • Savers who put their money into fixed income schemes and deposits will get a lower return as interest rates soften. They will have to settle down for lesser returns or move their money into alternate investments.

As growth accelerates, land consumption will increase

  • As economic activity sees a surge, asset prices will see a boost. Land consumption will increase. Industrial land demand goes up with increase in production; increased consumption of services need more commercial land and those earning high and moving into better houses increase the demand for housing. Towns will expand their peripheries quickly.
  • Inflation may not increase at the same pace of wages as the productivity benefits from the physical capital (infrastructure in place) starts paying off. Lower capital costs will give a breather for business profitability.
  • Increasing labors costs will not hurt business sentiment in the near future but take up the average income levels in India (and GDP per capita) like how it happened with our Asian neighbors (Taiwan, South Korea, now China). Even if our GDP per capita doubles from current levels, we would get close to that of Sri Lanka or Egypt. So I suppose there is scope for wage increase without impacting potential economic growth in near term.
  • This also means more people moving out of poverty zone, improved lifestyle for middle income population as the income gap will likely reduce from the current levels.

Simplified pictorial of economic cycle

How long this investment phase remains in action is hard to predict as it depends on various factors including political and global developments. Given the circumstances, it would continue for at least 3-5 years. When it tops out, that too will give many indications.
  • As the interest rates reduce in India but go up in advanced countries, interest rate spread reduces and the incentive for foreign debt investors to invest in India will reduce. So the fund flow into India would gradually reduce.
  • When wages rise beyond productivity improvements, it begins to hurt the prices of goods and services. Exports will suffer. Inflation catches up to fill the gap. That will ask for the interest rates to rise again and the next turn in the economy begins.

Before worrying about the next downturn, let us make most of what is in store for us and not forget to keep an eye on the indicators.