Is the Indian economy really decoupled?

In the second quarter, Indian GDP grew at 6.3%, which is in line with the estimate. There is feeling that the global economy and the Indian economy are decoupled. But is it really the case? Deja vu, we made a similar mistake in 2008 and for the next decade, our mistake haunted us in the form of higher NPAs.

The dynamics for the capex boom are all set to play out. There are various growth triggers such as cleaner balance sheets of Indian firms, government initiatives like PLIs, National Logistics Policy, Open Network for Digital Commerce (ONDC), lower corporate tax and higher spending on infrastructure. Also, China+1 is expected to aid investment in India.

Even though, dark clouds are hovering over the world economy, the domestic situation is better with the service sector leading the pack. However, it’s not all rosy. The manufacturing sector contracted 4.3% in the September quarter and 8 core sectors barely grew at 0.1% in October,  which is 20-month low. The rural economy is yet to pick up pace and government expenditure has actually declined in Q2 FY23.

The story of decoupling is based on the fact that India is a domestic demand-led economy with exports accounting for just 20% of GDP. But are we forgetting global spillovers in the form of supply chain disruptions, higher inflation, fall in rupee and forex reserves?

Now,  let’s talk about the benefits of rupee depreciation. Going back to basics will make you realize that the benefit of currency depreciation comes with a lag due to the J-curve effect. It is an economic theory that suggests it takes time for exports to increase and imports to fall after currency depreciates. The reason is stickiness in consumer behavior and trade contracts. Basically, it means that the rupee’s weakness will further worsen the balance of trade during the short term. Couple this with a global slowdown and it can become medium-term trouble.

The current account deficit for FY23 is estimated at 3.2%. Global headwinds will impact mood even in India and Indian businesses. As per the care edge report, the Operating margins of Indian companies have fallen to 13% in Q2 FY23, from 17% last year in the same period. The report also added that the cost of raw materials increased 42.2 % (YOY) and employee costs has gone up by 13.8% (YOY).

So, if companies invest more on expansion with no corresponding increase in sales, then they pave the road for higher NPAs.
On the bright side, there are, in fact, 2 scenarios in which Capex will actually yield fruitful results.
1) Capex for optimizing the production process or developing innovative products after a thorough analysis of customer preference evolution. This will lead to better profit margins for Indian companies despite headwinds.
2) Global economy may not face a severe slowdown. The output gap in developed economies is close to potential (Actual GDP is close to potential and there is not much slack left). Meaning even if the economy cools down a bit there won’t be a catastrophe, in fact, it is necessary to prevent inflation. Global inflation giant has started withdrawing, if it leaves quickly, then the situation would be ripe for a growth spurt. This will yield positive results for the CAPEX projects of Indian firms.
However, if the Russia-Ukraine war and China lockdown persist for a long time, then all bets are off and India is bound to feel the spillover effects. In that case, Capex will lead to a repeat of NPAs we witnessed last decade.