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Sunny days are still away

As against the general perception that the economy is poised for a recovery, this year may again see tepid growth

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This old article may have references to outdated tax rules and laws. For up-to-date information on taxation of mutual funds, refer to

Sunny days are still away

In contrast to the ‘V-shaped recovery’ seen by some CEOs of listed companies, I continue to see GDP growth being a struggle in calendar year 2017. This dynamic, which has three facets to it – a surge in unemployment in the informal sector, a drop in consumption by owners of small and medium enterprises (SMEs), and a drop in investment by businesses across the size spectrum – will gather momentum as the government’s crackdown on real estate and income-tax avoidance comes through and once the goods-and-services tax (GST) is implemented. I believe that we are heading for a year of sluggish GDP growth. On the other side of this pain lies a fitter economy with lower cost of capital and land.

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V-shaped recovery?
Some CEOs of listed companies have opined that their business has picked up materially in January as the worst impact of demonetisation has apparently subsided in spite of currency in circulation still being 40 per cent below that of early November. Leaving aside the fact that my colleagues’ channel-checks with the dealers, distributors and staff of these companies do not corroborate their CEOs’ view of a ‘V-shaped recovery’, there is, I believe, a more interesting dynamic at play.

In my meetings with small businesses across the country, I see informal-sector activity continuing to shrink alongside layoffs of workers. Such businesses account around 40 per cent of GDP and around 80 per cent of employment in India, and the worst-affected amongst them are SMEs whose costs and revenues have historically been in cash. Not only are such SMEs finding it hard to get cash to pay their staff and customers, the finance minister’s ban on cash transactions over `3 lakh will also impact this part of the economy. For many of these companies, the profit margin is basically due to tax evasion. So, once evading taxes becomes unviable, these firms will wind up.

Taking a broader view of the country as a whole, what seems to be underway is a transfer of economic activity from labour-intensive SMEs, which make extensive use of cash, to capital-intensive market-leading franchises. Whilst this is boosting the fortunes of the latter, the adverse impact on employment is likely to drag down consumption in the coming quarters (you can see proof of this in shrinking volumes for FMCG and two-wheeler manufacturers). Also adversely impacted are lenders to low-income people (micro-finance institutions continue to find it hard to collect money) and to the SME sector (businesses with black-money cash flows will find life getting harder as income-tax raids intensify; IT raids will intensify not least because the government’s budgeted tax revenue growth of 17 per cent in FY18 is heavily reliant on income-tax collections growing by 25 per cent YOY).

So what happens next?
Other than a surge in unemployment in the informal sector (a surge which is already resulting in MGNREGA claimants tripling in some of the northern Indian states as migrant workers return home), I also expect the soon-to-be-announced real-estate regulator crackdown on black money in real estate. This seems likely to be done through a crackdown on benami properties. That will then be followed by the launch of GST (in September 2017 most probably). Discussions with SMEs and listed companies suggest that this sequence of events (demonetisation, IT raids/black-money crackdown, benami crackdown, GST) is frazzling the hardiest of promoters and leading to:

  • Promoters postponing purchases of high-value items such a jewellery and expensive cars
  • Promoters postponing capex plans, as evident from the RBI’s latest industrial-outlook survey, which indicates a poor business sentiment
  • The banking sector’s loan-book growth grinding to a halt in India (in fact, loans outstanding in India have been stagnant for five months now).
  • Therefore, as the year wears on, I expect to see the economy slow down further (rather than showing a V-, U- or W-shaped recovery). As this slowdown progresses, the longer-term economic benefits of the crackdown will begin to emerge, namely,
  • The cost of capital will drop sharply as financial savings grow from around $270 billion per annum to $500 billion per annum by 2020.
  • The cost of land and real estate will drop sharply as black money is squeezed out of real estate.
  • Sectors which are reliant on large doses of capital and real estate, e.g., multiplexes, department stores, amusement parks, pathology labs, hospitals, etc., will see a surge in profitability (even as competition from their informal-sector competitors withers).
  • Companies which specialise in providing investors access to financial savings (e.g., asset managers, insurers) will prosper as the quantum of such savings grows rapidly.
  • Exporters of manufactured goods, who for decades have struggled to compete with China, East Asia and Bangladesh, will find the tide shifting in their favour due to cheaper land, cheaper labour, better roads and GST. Indian manufacturers of medium-tech products (small cars, two-wheeler manufacturers, auto ancillaries, pumps, gensets, air compressors, etc.) might finally be able to build large export franchises.

After the washout, the Indian economy will begin a new cycle of creation. Those who want to participate fully in the new cycle might want to conserve their capital as the washout plays out.

Saurabh Mukherjea is CEO - Institutional Equities at Ambit Capital and the author of The Unusual Billionaires and Gurus of Chaos.

This old article may have references to outdated tax rules and laws. For up-to-date information on taxation of mutual funds, refer to

Disclaimer: The views and opinions expressed here are solely those of the author and do not necessarily reflect the views held by Value Research and its employees.

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