The rebound in investment in India appears to have been stronger than anticipated over the past few months and we are revising up our estimates of Q3 GDP growth as a result. But the recovery faces several headwinds, meaning that investment will remain below its pre-virus trend for several years to come.
- The rebound in investment in India appears to have been stronger than anticipated over the past few months and we are revising up our estimates of Q3 GDP growth as a result. But the recovery faces several headwinds, meaning that investment will remain below its pre-virus trend for several years to come.
- Investment was hit particularly hard during the most acute phase of the lockdown, contracting by a colossal 48% y/y in Q2. However, monthly activity data indicate a relatively strong revival since then. The substantial improvement in capital goods output is consistent with the slump in investment easing to around -10% y/y in Q3. (See Chart 1.)
- That is considerably stronger than our initial forecast of a slower pace of recovery to around -20% y/y. As a result, we are revising up our forecast for Q3 GDP to -8% y/y, from -12% y/y previously. (For comparison, the RBI is forecasting a contraction in GDP of -8.6% last quarter.)
- But while the strength of the rebound is welcome, it is likely that much of this has resulted from delayed investment during the lockdown coming online as the economy has gradually reopened. Further gains will be harder to come by.
- Admittedly, policy support has been stepped up in recent weeks. For example, the government has recently extended the loan guarantee scheme for SMEs to the end of this month and it will probably remain in place for longer. But that will be cold comfort for the many firms that have seen their balance sheets take a pummeling. Corporate sales plunged by 36% y/y in Q2, the sharpest drop since data started being collected in 2005. Linked to this, capacity utilisation levels are well below normal. (See Chart 2.) That is hardly conducive to a continued pick-up in investment.
- Meanwhile, companies that have come out of the lockdown relatively unscathed are likely to remain cautious with long term planning given the uncertainty over the virus. While new COVID-19 cases in India have come down significantly since September, they remain high and the outbreak of second waves across the world illustrate the difficulties in stamping out the virus entirely.
- Even for those firms that are willing to look to the future, financing constraints are another headwind to investment. After all, the banking sector is in poor health. (See our Update, “Indian banks: the world’s weakest link”, 29th October.) We think the banking sector is now entering a slow-burning crisis, where bad debts will eat into profits and restrict lending. And it is unlikely that non-bank financials will pick up the slack, given that they entered the crisis still reeling from the large-scale default of the IL&FS Group.
- In all, the stronger-than-anticipated recovery in Q3 means that investment is likely to return to pre-virus levels sooner than we had anticipated, perhaps in the first half of 2021. But headwinds to the rebound still mean investment will remain below its pre-virus trend for many years to come.
Chart 1: Capital Goods Production and Investment
Chart 2: Capacity Utilisation (% Net Response)*
Sources: CEIC, Capital Economics
Sources: CEIC, RBI, Capital Economics