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Economy
Economic Outlook (PMEAC)

INDIA
AUGUST 01, 2011 UPDATE BSE-30: 18,314

PM EAC Report: Emphasizes on reforms to achieve 9% stable growth. The Council downgraded its FY2012E growth projection to 8.2% from 9% as the erosion in investor sentiment and the persistence of inflationary pressures were affecting investment demand. The report points to the challenges in sticking to the agreed fiscal consolidation path, by both the Centre and States, and stresses on the need to undertake key reforms in this area. Headline WPI is projected to moderate to 6.5% by March 2012, lower than RBIs target of 7%. Importantly, the report emphasized on the need to improve the investment rate to achieve a sustainable 9% growth.
FY2012E growth target likely to be capped at 8.2% The FY2012E growth target was lowered to 8.2% from 9% estimated in February 2011. The downward revision reflects the negative impact of high interest rates on manufacturing and construction. Additionally, operational constraints and policy hurdles are expected to keep mining sector output lower (Exhibit 1). Interestingly, the Council thinks it is unlikely that growth would exceed its revised target, in sharp contrast to the previous occasions when the Council has been confident of its growth projections. This change possibly reflects an implicit acknowledgement by the Council that there are downside risks to growth should the government dither on key reforms. In our opinion, even the revised growth target is optimistic as we expect sticky inflation, high interest rates and weak investment demand to result in FY2012E GDP growth closer to 7.3%. Headline inflation to ease to 6.5% by end-FY2012E The Council expects headline inflation to remain at 9% or above until October and thereafter moderate to 6.5% by March 2012. This is lower than the RBIs end-year projection of 7%. While firm global commodity prices, possibility of further upward adjustment in domestic administered fuel prices could keep inflation sticky in the near term, past RBI rate hikes is expected to see inflation moderate in 2HFY12E. We expect headline inflation to ease to 6.5-7% by end-FY2012E Fiscal consolidation a challenge (not just in FY2012E) in the absence of reforms The Council expects that the Centre and State governments could struggle to adhere to their budgeted fiscal consolidation paths this year. This is in sharp contrast to the PMs office that is confident of achieving the fiscal targets for the year. For the Centre, slippage on the expenditure side is likely owing to greater outgo on the fuel and fertilizer subsides, while custom and excise tax collections would be lower owing to the recent duty cuts and excise cuts. Importantly, the report points out that the medium term fiscal challenges are even greater, given the governments commitment to introduce universal education to secondary level, universalize healthcare and food security. Thus, there is an urgent need to introduce reforms to augment government revenues in the form of the DTC, GST etc. For the State governments, deterioration in the finances of State Electricity Boards poses a significant risk to their 2.1% GFD/GDP target and once again reforms in this area are critical to lower State government liabilities. We are also of the view, that there are several challenges to the budget estimates and expect GFD/GDP to be closer to 5.5% in FY2012E. Investments key to returning to high growth path The report emphasizes on the need to provide conditions conducive for investments which is a pre-condition to achieve and sustain a 9% growth trend. GFCF/GDP has dropped from 32.9% in FY2008 to 29.5% in FY2011, and as per the report, a 2-3% decline in the rate of capital formation could have 75-100 bps impact on the economic growth. The Council stressed on the need to provide clarity on policy, remove uncertainties both on the policy and administrative fronts and undertake key reforms as some of the key ingredients to improve the investment climate.

QUICK NUMBERS PMEAC revises down FY2012E growth to 8.2% from 9.0%; growth unlikely to exceed target Fiscal targets a challenge in FY2012E Urgent need to take steps to push the investment rate from 29.5%of GDP in FY2011 to around 32-33%

Indranil Pan
indranil.pan@kotak.com Mumbai: +91-22-6659-6354

Shubhra Mittal
shubhra.mittal@kotak.com Mumbai: +91-22-6659-6489

Suvodeep Rakshit
suvodeep.rakshit@kotak.com Mumbai: +91-22-6634-1409

Kotak Economic Research kotak.research@kotak.com Mumbai: +91-22-6634-1100 For Private Circulation Only.

India

Economy

Exhibit 1: PMEAC sees services sector compensating for slower growth in industrial and agricultural sector Growth in real GDP at factor cost and components, March fiscal year-ends, 2006-2011E (%)

2010 Agriculture and allied activities Industry Mining and quarrying Manufacturing Electricity, gas and water supply Services Construction Trade, hotels, transport, storage and communication Financing, insurance, real estate and business services Community, social and personal services Real GDP at factor cost non-agricultural GDP 0.4 8.3 6.9 8.8 6.4 9.1 7.0 9.7 9.2 11.8 8.0 9.4

2011 6.6 7.8 5.8 8.3 5.7 9.2 8.1 10.3 9.9 7.0 8.5 8.9

2012E 4.1 5.5 1.1 5.8 9.0 8.5 7.3 9.3 8.9 7.4 7.3 7.8

2012EAC (Feb) 3.0 8.6 7.5 9.0 7.0 10.4 10.5 11.0 10.5 8.8 9.0 10.0

2012EAC (July) 3.0 6.9 6.0 7.0 7.0 9.7 7.5 10.8 9.8 8.5 8.2 9.0

Source: PM EAC 2011-12 Outlook (July 2011), Kotak Economic Research estimates

Exhibit 2: External sector sees steady downgrade for FY2012 India's balance of payments, March fiscal year-ends, (US$ bn)
2010 Current account CAD/GDP (%) Trade balance Trade balance/GDP (%) - Exports - Imports Invisibles (net) Capital account Foreign investment - FDI Banking capital Loans Other capital account items (38.4) (2.8) (118.4) (8.5) 182.2 300.6 80.0 53.4 51.2 18.8 1.5 13.3 (13.0) 2011 (44.3) (2.6) (130.5) (7.5) 250.5 380.9 86.2 61.9 37.4 7.1 5.9 29.4 (10.4) 2012E (54.6) (2.7) 165.6 8.2 319.0 485.0 111.0 63.0 32.0 20.0 4.0 35.0 (8.0) (5.0) 2012EAC (Feb) (55.8) (2.8) (151.5) (7.7) 271.9 423.4 95.7 76.0 45.0 20.0 6.0 2012EAC (July) (54.0) (2.7) (154.0) (7.7) 330.2 484.2 100.0 72.0 32.0 18.0 6.3 35.2 (1.5)

Source: PM EAC 2011-12 Outlook (July 2011), Kotak Economic Research estimates

KOTAK ECONOMIC RESEARCH

"I, Indranil Pan, hereby certify that all of the views expressed in this report accurately reflect my personal views. I also certify that no part of my compensation was, is or will be, directly or indirectly, related to the views expressed in this report."

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