Europe and the US are headed for a recession in 2023 while China is on road to a bumpy recovery. Decoupling seldom works. Weak external demand and tighter global financial conditions will likely drive India’s FY24 growth down to ~5% (vs. ~7% in FY23). We think of 2023 as a year of adjustment, where growth slows down but at the same time becomes more balanced, setting the stage for a more sustainable recovery on the other side. Much of the growth challenges are global.
The corporate capex cycle, which has seen a modest expansion since mid-FY22, could take a mild breather in 2023. That said, strong balance sheets, PLIs, a decade-long of minimal capex activity, and mushrooming new age industries make a case for a strong medium-term corporate capex cycle. China + 1 is a durable reality today as global firms diversify their production in other countries. India is also on the cusp of revival in real estate construction after a decade-long dormancy.
Consumption is likely to stand as a relatively resilient sector in 2023, aided by improving low-end jobs and ebbing inflationary pressures. The year will likely throw interesting opportunities in the mass consumption segment. On the other hand, salary growth in metro cities corporate jobs could moderate with slowing global growth (IT sector is case in point).
Fiscal policy may not be able to consolidate materially in a pre-election year. States’ capex has been lagging since COVID. Whether this is a bell weather to deeper problems underneath or just a temporary pause could unfold better in 2023. We expect combined government deficit to narrow by a modest 20-30bps.
As we stay positive on the medium-term earnings outlook for India, tax-to-GDP can improve in coming years. Though, careful targeting of subsidies and revenue generation is the only way the central deficit can be consolidated by 2% of GDP by 2025-26, without compromising physical and social infrastructure spending.
But for global shocks, India’s inflation will moderate in 2023. Even if commodity prices were to stay flat, WPI inflation will be significantly low. Flat energy prices and reduced aggression in core price hikes imply CPI inflation could soften to ~5%. Food inflation still entails pockets of uncertainty.
Softer inflation implies a sharper moderation in nominal GDP growth to high single-digit in FY24 (vs. 16% in FY23E). Yet, normalisation in private credit demand and substitution away from external loans (more so in 1H2023) will likely keep domestic credit growth elevated.
Given our outlook on elevated government borrowings and risks to external capital flow, credit recovery could drive the cost of funds higher, unless RBI steps in to normalize liquidity conditions. Banks’ SLR investment could scale down in the immediate months, but further dip could get arrested as growth and capex moderate.
RBI policy action in FY24 will depend not only on domestic growth-inflation dynamics but also on global financial conditions. The domestic growth inflation outlook makes a case for a softer policy but if global financial conditions remain hostile next year, external spillovers will dominate with the continuing focus on how the CAD will be funded.
Cost attractiveness for dollar borrowings has sharply reduced putting dollar loan-related capital inflow at risk. BoP concerns remain. We will watch out for crude price dynamics and FII sentiments towards Indian assets. FX reserves below $500 billion would test India’s reserve adequacy.
For currency, it could be a year of two halves. US treasury yields have retraced from the peaks in the last two months of 2022 and the dollar has dialled back some of its strength. Today, the market broadly agrees with the Fed on the terminal rate but disagrees with the timing of rate cut commencement. These assumptions could get tested over the next few months. As such, 10-year UST and the dollar could rise before it glides softer. Near-term INR depreciation risks stay. However, when we call out 6-12 months ahead, a repeat of 2022 is less likely. Rupee could be range bound.
Indian equity consolidated through CY2022 even as volatility was high. While inflationary pressures should moderate, growth slowdown may intensify, keeping the 2023 earnings outlook muted. Macro uncertainty limits valuation upside through a rise in equity risk premium. 2023 may, therefore, continue to be a year of volatility for equities, at least in the first half.
We are positive on fixed-income assets even as we recognize few risks from the eventual global monetary policy trajectory, tightening domestic liquidity, rising credit, and foreign capital inflow. Our positivity stems from maturing monetary tightening cycle, benign inflation trajectory and valuation attractiveness relative to other assets.
From an asset allocation point of view, diversification beyond equities into bonds and gold may help in 2023.
(Author: Namrata Mittal is CFA & Senior Economist)
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