This report is available to users in India for ₹5,000 + applicable taxes

Executive summary

After two sub-par years, interjected by demonetisation and rollout of the Goods and Services Tax (GST), growth is seen recuperating to a respectable 7.5% next fiscal. This, however, is still below the 13-year average.

The key engines supporting the upturn are largely domestic and policy-driven, though a synchronous upturn in global growth will, undoubtedly, provide some tailwind.

While the upturn is a given, aided partly by the low-base effect, we identify four thrust vectors – the four Rs – that will critically determine the extent of pick-up and its sustainability.

• Resolution of stressed assets in banking
• Rural rejuvenation
• Relentless implementation of reforms, and
• Rising global growth

Resolving NPAs through NCLT, especially fromthe steel sector…

The asset quality issues plaguing the public sector banks have reached such gargantuan proportions – with gross non-performing assets(GNPAs) touching 10.5% - that no meaningful and sustainable economic recovery is plausible without, at least, beginning of a resolution process.

The transparent and time-bound process drivenby National Company Law Tribunal (NCLT) offers hope. While haircuts are likely to be deep – at 60%+ in our view in many large cases – the scale and timeframe of recovery will mark a watershed for Indian banking.

We are particularly positive on the steel sector, helped by buoyant global prices and recoveringdomestic demand.

With improving economy and turning credit cycle, fresh slippages will moderate and NPAs will likely peak at 11% by March 2019. Continued government support though capital infusion, including growth capital, will, however, becritical for the lending cycle to start, a requisitefor growth step-up.

…but that would push back private investments

An unintended consequence of resolution will be possible slowdown or deferment in private sector capex. This will be driven by two factors – improvement in the utilisation of stressed capacities that move into stronger hands, and reduced financial and management bandwidth for acquirers, especially the strategic ones, fornew large projects.

Centre’s rural focus will drive jobs and demand

The focus on demand and job creation throughspending on rural and labour-intensiveinfrastructure space is likely to support growthnext fiscal, and push demand in the consumersectors.

Funding, though, remains a concern – withsignificantly higher reliance on non-budgetaryresources for supporting the aggressivespending plan on rural roads, affordable housingand railways.

Progress on reforms mixed, so big tractionunlikely from that

The sustainability of recovery also dependson effective implementation of key reformssuch as GST, the Real Estate (Regulation andDevelopment) Act, 2016, or RERA, and theUjwal Discom Assurance Yojana (UDAY), rolledout in the last few years. Each of these has thepotential to be transformative in the long run,but near-term efficacy and impact, in our view, ismixed at best.

The most urgent need is to iron out the teething6troubles with GST, and ease its impact on critical segments such as micro and small enterprises (MSMEs) and exports.

Besides, tax collections remain subdued despite high enrolments. Streamlining procedural issues and improving compliance will be critical for businesses to refocus on growth and fiscal target to be met. Our forecast bakes in stabilisation in the first half of next fiscal.

UDAY, the third attempt to streamline state electricity boards (SEBs), has seen reasonable progress with some states making stronger tariff hikes, but progress on other key fronts, including reduction in transmission and distribution losses, remains slow. Without improvement in SEBs’ fortunes, power offtake, new power purchase agreements and resolution of stress in private sector gencos appears distant.

RERA has also muddled through with lack of uniform implementation. Maharashtra has taken the lead, but many states have diluted the provisions, numbing the overall impact. While RERA has increased the cost of compliance and is expected to lead to consolidation in the sector, our analysis of launch activity in the last two years suggests no meaningful change. Admittedly, for a highly fragmented sector with deep-rooted practices, change is expected to be only gradual. However, for the benefits – lower risk, improved transparency – to flow through, more forceful implementation needs to be pursued.

On the other hand, the affordable housing segment is witnessing unprecedented action from both, the government and private sector. We expect the momentum in this area to gather pace in fiscal 2019 with higher budget allocations and increasing attention of private players, given subdued demand in other segments.

Global growth resurgent, but exports are unlikely to be on a tear

Global growth is gathering pace, and the momentum in global trade is expected to continue in 2018 as well. This should buoy India’s exports, but the pick-up is unlikely to be material, given poor local infrastructure, higher cost of capital and labour productivity issues. This needs urgent mend since, as S&P Global Chief Economist Paul Gruenwald points out in our report, global growth is unlikely to sustain at these levels beyond the next 1-2 years.

Corporate performance to mirror macros, EBITDA growth to hit double digits

Corporate performance will mirror improving macros with revenue growth exceeding inflation meaningfully for the first time in over five years. We expect India Inc (excluding banking, financial services and insurance, and oil and gas companies) to report double-digit growth in earnings before interest, tax, depreciation and amortisation (EBITDA) for the first time in eight years. Revenue growth, too, is projected to touch a seven-year high.

Key risks to our forecasts

The big picture shows improving growth dynamics and domestic consumption, infrastructure spending doing the heavy lifting and supportive tailwinds from global growth and exports.

The key risks to our forecasts stem from inability to resolve GST-related issues quickly and fiscal stress leading to a cut in capex by the government.

On the global side, faster-than-expected rate increases by central banks, flashpoints in trade policies, and geopolitical events impacting crude oil prices are among risks to other macroeconomic forecasts.

But with more dominant domestic drivers falling in place, we remain convinced of a meaningful, though below aspirational level, recovery in macro and micro growth for fiscal 2019.