India’s current economic boom similar to that of 2003-07? Morgan Stanley thinks so, lists 5 parallel trends

In a recent note, global brokerage house Morgan Stanley believes that the current India's economic boom closely resembles that of 2003-07.

"After a decade of investment to GDP steadily declining, capex has emerged as a key growth driver in India. We think the capex cycle has more room to run, therefore the current expansion closely resembles that of 2003-07," it said.

As per the brokerage, the defining characteristic of the current expansion is the rise in the investment-to-GDP ratio. During the 2003-07 cycle, investment to GDP surged from 27 percent in FY03 to 39 percent in FY08, nearly reaching its peak. Subsequently, it remained around those levels until reaching its pinnacle in FY11. However, from 2011 to 2021, there was a decade-long decline in this ratio. Nevertheless, it has recently turned around, now standing at 34 percent of GDP, with expectations of further growth to 36 percent of GDP by FY27E, noted MS.

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What was 2003-07 like?

The brokerage observed that the capex boom during this period led to a surge in productivity, job creation, and income growth. With a strengthening economy absorbing more labor into employment, savings-to-GDP ratios also increased. Despite robust growth, macro stability concerns remained minimal. From 2003 to 2007, GDP growth averaged 8.6 percent, while headline CPI inflation averaged 4.8 percent. The current account balance also remained within the central bank's comfort zone, fluctuating between 2.8 percent to -1.4 percent of GDP on a 4-quarter trailing basis. Even when oil prices spiked to US$145/bbl in July 2008, the current account deficit only expanded to 2.4 percent of GDP in the subsequent quarter, it pointed out.

Five important characteristics of this cycle

MS has also highlighted the following five characteristics, which should help investors frame their approach to India in this cycle.

Investment to outperform consumption: The brokerage observed that Gross fixed capital formation (GFCF) growth in India accelerated sharply from 8.2 percent in 2002 to 17.5 percent in 2004, and the pace of growth held firm at 16.2 percent in 2005-07. In that cycle, the fiscal deficit was already consolidated, the banking system’s non-performing loan issues were cleaned up and the economy was poised for a capex upswing, it added.

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This cycle too, investment growth has been stronger, said the brokerage. The real GFCF growth continued to hold strong at 10.5 percent in Q4FY23, staying above the pre-Covid 2017-18 average of 9.6 percent. This has been mainly driven by public capex so far, as the corporate sector has been working through multiple shocks from previous years that have weighed on its ability to invest, added MS.

Public capex leads initially, but private capex rapidly catching up: The brokerage also pointed out that policymakers’ concerted policy push on supply-side reforms in recent years has meant that real government fixed capex growth inflected higher from FY20. Government fixed capex as a percentage of GDP rose from a trough of 3.6 percent in FY19 to 4.0 percent in FF21, again picking up ahead of private capex.

In contrast, private capex rather than public capex drove the broader capex cycle in 2003-07, as favorable external demand conditions provided a strong uplift to private capex. However, the lagged increase in public capex to GDP meant infrastructure remained a key constraint for growth, said MS. The brokerage believes it is important for the public sector to undertake such spending to ensure a clearer runway for private capex to take off by eliminating supply-side bottlenecks ahead of time.

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Within consumption, the urban consumer leads, followed by a catch-up in rural demand: Similar to the 2003-07 cycle, urban demand is driving rural demand in the current economic cycle, noted MS. Urban areas typically experience faster job and income recovery, with benefits extending to the informal sectors of the urban economy. As the cycle progresses and remittances from urban workers to rural areas increase, rural consumption is expected to pick up. However, rural incomes, primarily derived from farming, often lag behind urban areas. In the previous cycle, rural demand initially trailed urban demand but caught up later. In the current cycle, successive shocks, such as the Covid-19 pandemic and elevated inflation, have delayed rural recovery. These shocks disproportionately affected lower-income households in rural areas. Nonetheless, there are indications of rural household finances improving, which suggests a positive outlook for rural consumption, it explained.

Market share in global exports will rise: In the previous cycle, global trade flourished alongside strong global growth, propelling India's combined market share in goods and services from 0.8 percent in Q4FY02 to 1.4 percent in Q4FY07, particularly in services. Similarly, in the current scenario, India's goods and services exports market share has increased from 2.2 percent pre-Covid to 2.5 percent, primarily driven by gains in services. The COVID-19 pandemic prompted outsourcing trends, boosting India's services segment, which now holds a global market share of 4.8 percent, up from 3.7 percent in December 2019, it observed. Looking ahead, India is poised to benefit from international supply chain diversification efforts, supporting further gains in goods market share.

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Macro stability risks will be kept in check: In this cycle, macro stability risks are less concerning compared to the previous one. The key question revolves around whether productivity is the driving force behind the cycle. In the previous cycle, macro stability risks were prominent, with inflation persisting around 10 percent from 2009 to 2014, and a relatively wide current account deficit averaging 3.0 percent of GDP over the same period, argued the brokerage. It anticipates inflation to sustainably moderate to 4.5 percent, leading to a shallow rate cut cycle of 50 basis points in our base case. This would mean that the Reserve Bank of India (RBI) will likely maintain real rates around 150 basis points, higher than the neutral levels outlined in a recent RBI paper. Moreover, if growth outcomes surpass expectations, it would lessen the need for the RBI to consider rate cuts further, it added.

Outlook

The brokerage has been constructive on India’s macro outlook and remains so. It believes that the capex-driven nature of the expansion lends sustainability to the growth cycle and will likely keep macro stability concerns in check. However, constraints to the growth cycle may potentially emerge in the next 18-24 months if the growth cycle remains strong in the form of labour and logistical bottlenecks emerging, it cautioned.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.