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CRISIL Insight

India: Outlook Revision 2012-13

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Last updated: April 30, 2012

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India: Macroeconomic Outlook Revision 2012-13

2011-12 Actuals Agriculture GDP Growth Industry Services Total Inflation Interest rate Exchange rate Fiscal deficit WPI Average 10- yr G-Sec (March-end) Re/US$ (March end) % of GDP 2.8 3.4 8.9 6.5 8.8 8.8 51.2 5.7 2012-13 March 2012 3.0 5.6 8.7 7.0 6.5 7.5-7.8 48.0-49.0 5.5 2012-13 Revised ForecastJune 2012 3.0 5.0 8.1 6.5 7.0 8.0-8.2 50.0 5.8

Source: Central Statistical Organisation (CSO), RBI, CCIL, Ministry of Finance, and CRISIL Research

GDP growth: With rising uncertainty in the Eurozone, muted investment demand, and a policy logjam, GDP growth in 2012-13 will remain around the 2011-12 level of 6.5 per cent. Services growth is being revised downward to reflect the sluggish growth in IT/ITES as a result of slowing export demand from the Eurozone, and slower-than-earlier-anticipated growth of the hotels, trade and transport sector due to moderation in private consumption growth. Although industry may benefit from expansion of the mining sector on a low base, manufacturing and construction growth will remain weak due to limited scope for reduction in interest rates, and weak investment demand. Sub-normal monsoons and a further worsening of the Eurozone situation can create downside risks to our tepid growth forecast of 6.5 per cent for 2012-13. Inflation (WPI): WPI inflation forecast is revised upward to 7.0 per cent to reflect the higher-than-anticipated increase in food inflation, and the impact of the weak currency. The weak rupee is offsetting the gains from lower global crude oil and commodity prices, and will keep the cost of imported items high. Lower growth in 2012-13 will reduce demand-side pressures on inflation, but there are other pressure points that may keep inflation at elevated levels. For example, decisions on revision of electricity prices, increase in minimum support price for food crops, revision in prices of diesel, kerosene, and LPG all have the potential to enhance inflationary pressures in the economy. Fiscal deficit: With slower GDP growth compared to the earlier projection, government revenue growth will be lower than estimated earlier, thereby raising the fiscal deficit forecast to 5.8 per cent of GDP. 10 year G-sec yield: A higher fiscal deficit would increase the governments borrowing requirement and push the 10year G-sec yield higher than our earlier projection. We expect a 25-50 basis points (bps) cut in the repo rate by Reserve Bank of India (RBI) in the rest of the fiscal year to protect growth. Even if the repo rate is cut more aggressively than this, the downside to 10-year G-sec yield below 8.0-8.2 per cent is limited, given the size of the government borrowings. Exchange rate (Rs/US$): The rupee is projected to settle around 50 per US$ by March-end 2013 in the base case scenario. An appreciation of the rupee from the current level would be supported by a slight easing of the current account deficit in 2012-13 and return of foreign capital inflows towards the last quarter of the fiscal year. This assumes some improvement in the Eurozone situation by early next year which will improve the risk appetite of foreign investors. Any significant worsening of the Eurozone crisis however, can result in capital inflows being lower than the scenario mentioned above. In that case, the rupee could settle at a level higher than 50 per US$ by March-end 2013.

CRISIL Insight
India: Macroeconomic Outlook Revision 2012-13
India to grow at 6.5 per cent in 2012-13
CRISIL Research believes that due to rising uncertainty in the Eurozone and muted domestic demand, particularly in the case of investment, GDP growth would remain restricted to 6.5 per cent in 2012-13. In view of the downward revision by Central Statistical Organisation (CSO) of 2011-12 GDP growth to 6.5 per cent from its advance estimate of 6.9 per cent, the overall growth prospects of the Indian economy have declined much more than anticipated. In terms of numbers, the growth performance in 2011-12 is Indias worst in the past nine years and a repeat of that in 2012-13 will make it two in a row. The Indian economy is in the grip of an investment slowdown, and growth momentum is weakening. This would be reflected in relatively weak industrial (mining, manufacturing, construction, electricity, and water & gas) growth, which has been revised down to 5.0 per cent compared to our previous forecast of 5.6 per cent. Although industry may benefit from the mining sector expansion on a low base, manufacturing and construction growth will remain weak due limited scope for reduction in interest rates, and weak investment demand. Export growth, despite currency depreciation, would moderate due to slowing growth in the countrys export destinations, notably Europe. This will also be reflected in low manufacturing growth. Services sector growth has been revised down to 8.1 per cent from 8.7 per cent to reflect sluggish growth in business services (which includes IT/ITES) as a result of slowing export demand from the Eurozone, and slower-than-earlierexpected growth of the hotels, trade and transport sector due to moderation in private consumption growth. Agricultural growth of 3.0 per cent assumes normal monsoons. A sub-normal monsoon presents a downside risk to this forecast Figure 1: Real GDP growth, Sector-wise, y-o-y %
8.4 6.5 6.5 7.0 7.2 5.0 3.0 2.8 3.4 9.3 8.9 8.1

FY11

FY12

FY11

FY12

FY11

FY12

FY11

FY13F

FY13F

FY13F

FY12
Services

GDP

Agriculture

Industry

F: CRISIL Forecasts Source: CSO, CRISIL Research

What can deepening of the Eurozone crisis do to Indias growth?

With the Eurozone crisis far from being resolved, there are downside risks to our base case scenario, which assumes zero per cent growth in 2012 in Eurozone with a mild recovery towards the end of the year. The national elections in Greece on June 17 have turned into a referendum on the austerity pact and at this juncture, a partial default by Greece and its exit from the Eurozone cannot be completely ruled out. These developments could intensify the Eurozone crisis and threaten the prospects of a mild recovery towards the end of the year. With deep recessionary forecasts for Greece,
th

FY13F

Portugal, Spain, and Italy for 2012, the banking stress in these countries, especially Spain, can worsen more sharply in the coming months. The worsening recessionary environment in the Eurozone would threaten the fragile economic recovery in US, and create downside risk to our GDP growth forecast of 6.5 per cent for 2012-13. In that case, we reckon that Indias growth would slip below 6.0 per cent. In such an adverse scenario, we believe that the government would be compelled to roll out a fiscal stimulus, despite the burgeoning fiscal deficit. However, it is likely that additional government spending would be increasingly focused on stimulating investment demand rather than boosting consumption demand alone, given the inflationary consequences of the latter. Despite a depreciated rupee, export growth is also expected to weaken substantially in this case due to slowing global demand. Under this scenario, CRISIL Research forecasts that the industrial sector would be the most impacted, with growth slowing down to 3.5 per cent compared with 5 per cent in the base case. Manufacturing would slow sharply due to muted domestic demand and declining investor confidence. The services sector is expected to moderate to 7.5 per cent due to a sharp slowdown in the trade, hotels, transport and communication sector despite a resilient community, social and personal services sector, to reflect the government stimulus, just as in the 2008-09 crisis. Given the weak global economic conditions, boosting investor confidence in the governments ability to tackle the shortterm and long-term challenges to sustain growth, especially demonstrating its ability to push through key reforms related to land, labour, taxation and government expenditure would hold the key to raising Indias growth prospects over the medium run.

WPI inflation to average 7.0 per cent in 2012-13

Despite our outlook of lower growth, we have revised our forecast on WPI inflation upward to 7.0 per cent for 2012-13 from 6.5 per cent previously. At 7.0 per cent in 2012-13, inflation will nevertheless be lower than 8.8 per cent witnessed in 2011-12. Lower inflation in 2012-13 compared with 2011-12 is mainly due to a high base and lower pricing power of corporates (led by sluggish domestic demand). CRISIL Researchs upward revision of inflation takes into account the recent escalation in food inflation momentum, and the rupees continued, sharp weakness that has exerted additional pressure on the imported component of inflation. Upward pressures on inflation emanate from a higher fuel inflation forecast due to the likelihood of an increased passthrough of international fuel prices into domestic retail prices, the impact of indirect tax rate hikes, electricity price revision, and increase in minimum support price for food crops. WPI inflation, which had been declining since October 2011, reversed course in February 2012, and rose to 7.2 per cent in April 2012. For 2011-12 as a whole, inflation averaged 8.8 per cent, with primary group inflation at 9.9 per cent, fuel inflation at 13.4 per cent, and manufactured products inflation at 7.2 per cent. For 2012-13, although manufactured group inflation will be lower vis--vis the previous year, primary group inflation is expected to remain high. Despite the expected pass-through of international oil prices into domestic retail prices, overall fuel inflation could be lower than 2011-12, as other components of fuel category such as aviation turbine fuel, naphtha, furnace oil, bitumen and other lubricants, which are directly linked to international prices, will see lower inflation because of slower global demand. We do not expect significant upward revisions in diesel, kerosene and LPG prices in our inflation forecast. Lower inflation in manufactured group is premised on lower demand-side pressures on inflation due to the slowdown in

CRISIL Insight

growth. With lower pricing power of corporates, core inflation pressure, both as reflected in non-food manufacturing inflation and CRISIL core inflation indicator (CCII) will also remain low. Figure 2: Sectoral inflation, 3-month moving average, y-o-y %
16.0 14.0 12.0 10.0 8.0 6.0 4.0
Oct-11 Oct-11 Oct-11 Oct-11 Oct-11 Apr-11 Apr-12 Apr-11 Apr-12 Apr-11 Apr-12 Apr-11 Apr-12 Apr-11 Aug-11 Aug-11 Aug-11 Aug-11 Aug-11 Dec-11 Dec-11 Dec-11 Dec-11 Dec-11 Jun-11 Jun-11 Jun-11 Jun-11 Feb-12 Feb-12 Feb-12 Feb-12 Jun-11 Feb-12 Apr-12

2.0

Overall inflation

Primary Articles

Manufactured Products

Fuel products

CRISIL Core Inflation Indicator

Source: Ministry of Commerce and Industry, CRISIL Research

10-year G-sec yield seen around 8.0-8.2 per cent by March 2013
CRISIL Research now expects the 10-year government security (G-sec) yield around 8.0-8.2 per cent by March-end 2013 as compared to our earlier forecast of 7.5-7.8 per cent. With GDP growth expected to be lower than previously anticipated, the governments revenue growth would be lower than earlier estimated, thereby raising fiscal deficit further. This would increase the governments borrowing requirement and, consequently, push the yields above our earlier projection, in a scenario of already tight liquidity and muted capital inflows. Figure 3: 10- year G-sec and repo rate (%, year-end)
10.0 9.0 8.0 7.0 6.0 5.0 4.0 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13F
F: CRISIL Forecasts Source: RBI, CRISIL Research

10-year G-Sec

Repo

The 10-year benchmark G-sec yield is, by definition, a weighted average of the current one-year rate (the floor) and oneyear forward rates for the next nine years. Forward rates depend on the extent of term premium over and above the floor. The floor to the 10-year G-sec is determined by the repo rate. Even if the RBI cuts the repo rate more aggressively than what is expected at present in order to boost growth, there would be limited downside to 10-year G-sec yield. A higherthan-budgeted government borrowing programme, resulting in higher supply of government securities, would keep up the upward pressure on 10-year G-sec yield.

Fiscal deficit to GDP to rise to 5.8 per cent

CRISIL Researchs revised estimate for fiscal deficit is 5.8 per cent of GDP for 2012-13 compared to its earlier estimate of 5.5 per cent and governments estimate of 5.1 per cent. The forecast revision has been done to account for the adverse impact arising from the CSOs downward revision of GDP growth. Lower-than-previously-anticipated GDP growth would result in lower government revenue growth, thereby expanding the absolute size of the fiscal deficit. Further, the strain on government expenditure would remain high unless prices of regulated fuels such as diesel and kerosene are revised upwards. According to CRISIL Research, the recent hike in retail petrol prices is not sufficient to reduce the governments subsidy burden to the budgeted levels until the prices of diesel, liquefied petroleum gas and kerosene are not revised by around 15 per cent. The governments revised estimate for the fiscal deficit to GDP ratio for 2011-12 stands at 5.7 per cent compared to the earlier estimate of 5.9 per cent Figure 4: Fiscal stress
% of GDP 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 FY 08 FY 09 FY 10 FY 11 FY 12 RE FY 13 BE
RE: Revised Estimates, BE: Budget Estimates, F: CRISIL Forecasts Source: RBI, CRISIL Research

Budgeted fiscal deficit

Actual fiscal deficit

5.8

Rupee to settle around 50 per US$ by March-2013

In the base case scenario rupee appreciation from the current level to around 50 per US$ by March 2013 would be supported by some easing of the current account deficit in 2012-13 and return of foreign capital inflows towards the last quarter of the fiscal year. Higher capital inflows at that time vis--vis today are based on the assumption of an improvement in the Eurozone situation towards the end of the fiscal, which would improve the risk appetite of the foreign investor. That would lead them to consider the advantages India offers due to Attractive Indian equity markets because of the sharp rupee depreciation and correction in equity prices Indias interest rate differential with United States Over-400 bps growth rate differential that India will maintain with the West, despite lower growth.

Any significant worsening of the Eurozone crisis, however, can result in lower capital inflows compared to the scenario mentioned above, due to higher risk aversion from investors. Despite a sharper drop in international commodity prices, drying up of capital flows into India would keep the rupee weak. In such a case, the rupee could settle at a level higher than 50 per US$ by March-end 2013.

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Figure 5: Currency movements

INR/USD 52.0 51.0 51.2 50.0

50.0

48.0

46.0 45.1 44.0 FY09

F: CRISIL Forecasts Source: RBI

44.7 FY11 FY12 FY13 F

FY10

Current account deficit to GDP seen at 3.6 per cent in 2012-13

CRISIL Research expects the current account deficit (CAD) to settle at 3.6 per cent of GDP in 2012-13 compared to our revised forecast of 4.0 per cent of GDP in 2011-12. This is on account of expectations of a mild recovery in the Eurozone towards the end of 2012 under the base case scenarip, which will lend some support to exports. The import bill is also expected to be lower on account of softening of global commodity prices. Gold and oil imports have already begun to show moderation. Also, we expect the rupee to appreciate from the current low levels, lending some comfort to the import bill. Figure 6: Current account under stress
% of GDP FY06 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0 -3.5 -4.0 -4.5
F: CRISIL Forecasts Source: RBI

FY07

FY08

FY09

FY10

FY11

FY12F FY13F

-1.2

-1.0

-1.3

-2.3 -2.8 -2.7 -3.6 -4.0

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