fearful symmetry

November 2011

a monthly chronicle of the Indian economy

Welcome to Westpacs monthly chronicle of the Indian economy, as seen through the penetrating gaze of fearful symmetry. A month ago fearful symmetry spent the bulk of this chronicle
bemoaning the RBIs late cycle tightening zeal. At the heart of fearful symmetrys critique is the lack of respect being shown to the looming transmission of a substantial negative financial shock, which in tandem with the clearly observable slowdown in domestic activity should be trusted bring inflationary pressure to heel in 2012 (and also 2013) without the tightening action seen in the second half of this year. (As an aside, the release of the minutes to the meeting of the RBIs Technical Advisory Committee, a panel of external experts, conducted in preparation for the latest policy review, recommended no change in rates). Looking further out, policy will be leaning against activity at a time when it would be more appropriate for it to be providing support for growth. That raises the likelihood of a need to ease policy not long after the last hike. In turn that would imply a substantive failure on one of the basic criteria for assessing the quality of policy decision making: that policy did not create undue volatility in the real economy.
64 60 56 52

Indian monetary policy, activity and inflation

index
Sources: CEIC, Westpac Economics.

%pa/yr

12 10 8 6 4

Rate corridor (rhs)

2 0 -2 Mar-08 Mar-10

48 44 Mar-04

Manufacturing PMI (lhs) WPI (rhs)

Mar-06

Foreign capital inflow & domestic investment

60 %yr
Other (mainly loans) Portfolio investment Direct investment Capital goods output (lhs) Basic balance

%GDP

The RBIs policy committee has not met since late October, so there
is no specific policy decision to decry or applaud, but the steady drumbeat of decelerating global growth continued unabated. The European climate worsened in both the real economy and financial arenas. Business surveys continue to reflect corporate anxiety. The open economies of East Asia showed further signs of a weakening in trade activity. A number of central banks, representing a broad variety of development levels/national and sectoral balance sheets/ industrial structures/degrees of outward orientation/resource endowments, moved to ease monetary policy. Global inflation was on the wane in both developed and emerging markets. Exchange traded metals prices, a bellwether for the heavy industrial cycle, are significantly lower than at mid year. Steel output has slowed considerably. Indicators of the state of the tech sector are very weak. Banks on both sides of the Atlantic reported weak earnings - or losses - in the September quarter. The only real exceptions to the negative trend have been a firmer tone to the US activity data and the resilience of the oil price. Such is the state of the world. The view that the first half of 2012 and the latter moments of the current year will be a very difficult time for global growth - and for the global financial system - underpins fearful symmetrys perspective on India.

40

20

0
Sources: CEIC, Westpac Economics.

-20 Jun-98

-3 Jun-00 Jun-02 Jun-04 Jun-06 Jun-08 Jun-10

Foreign bank claims on India

350 300 250 200 150 100 50 0 Mar-00
Sources: BIS, Westpac. Shares of total outstanding as of Dec-2010 in parentheses.

$USbn US (22%) UK (25%) Change over the year (rhs) Japan (6%) Europe (47%) Total outstanding (lhs)

$USbn

120 100 80 60 40 20 0 -20 -40

The reality is that while India is an internally focussed and

investment-led economy - thus producing a low-beta response to swings in global growth - the financing of investment, at the margin, must come from abroad, so it is highly vulnerable to downswings that incorporate or are driven by negative financial shocks. Put simply, in India a slowdown in the global economy is felt principally through the hardening of its external financing constraint. That is in contrast to the majority of its East Asian (surplus) neighbours, where global shocks are primarily transmitted via an export-led deceleration in aggregate demand, or its non-China BRIC peers, where swings in commodity prices are the key variable. Simply put, Indian growth cannot register at or above potential at a time of
Westpac Institutional Banking Group Economic Research

Mar-02

Mar-04

Mar-06

Mar-08

Mar-10

pronounced home bias among global investors and therefore the only plausible activity backdrop for ones present inflation forecast is a disinflationary one.

Indias basic balance - the degree to which it is able to overfund its current account deficit is highly correlated with two
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fearful symmetry
a monthly chronicle of the Indian economy
India: business surveys show softer demand
65 60 55 50 Services 45 Composite Manuf 40 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 40 45 index
Sources: CEIC, Markit.

vital indicators: domestic capital goods output and changes in the investment share of GDP. Prospects for the basic balance come down to Indias ability to attract both portfolio and banking inflows. That is a vulnerable position to inhabit when European banks are in a dire situation and the global fund management communitys appetite for emerging market risk is in serious question. fearful symmetry feels safe assuming that his assertion on European banking will not spark any informed controversy. The fact that European lenders contribute almost one half of Indias foreign lending flows, and UK banks contribute another quarter, is clearly cause for concern. In the portfolio space, while October was a decent month under the circumstances, with foreign institutional investors (FIIs) acquiring a net O17bn of Indian equity and O14bn of Indian debt, it would be unwise to expect on-going reliability on this front. Looking at the year to date performance of Indian equities (29%) against MSCI BRIC (16% local currency terms), Eurostoxx (19%), US S&P 500 (3%) and the Nikkei (18%), and the beleaguered rupee (7% weaker against the US dollar since the beginning of August) highlights the potential problem. fearful symmetry has heard the dreaded stagflation moniker attached to India by more than one EM fund manager. That is not a designation that encourages foreign investors to form an orderly queue for the entry: more likely a disorderly scramble for the exit. It has not yet come to that, and nor should it given the inflation story will correct soon enough, but for the moment India does not resemble a compelling buy.

index

65 60 55 50

Indian industrial output

30 25 20 15 10 5 0 -5 -10 Jan-01
Sources: CEIC, Westpac Economics. 3mma.

%yr
Total (lhs) Infrastructure industries (lhs) Consumer durables (lhs) Capital goods (rhs)

%yr

60 50 40 30 20 10 0 -10 -20

Turning specifically on the activity picture, industrial production

continues to underwhelm, even alarm, with its sluggish performance. Industrial production rose just 1.8%yr in September, down from 3.6% in August. It recorded a 3.1% pace in Q3 down from 7.0% in the June quarter. The deceleration has been concentrated in the capital goods and infrastructure space, consistent with the above thesis of weak capital inflows damaging the investment cycle. Consumer durables have maintained an average pace in the high single digits, but with the bellwether automobile sector seeing weak sales turnover, this is unlikely to persist. The infrastructure subset slowed to 2.3% in September, after averaging 5%yr in the June quarter. fearful symmetry argues that the official data is now validating the signal coming from the manufacturing PMI since June.

Jan-03

Jan-05

Jan-07

Jan-09

Jan-11

Contributions to monthly WPI inflation

2 ppt
Sources: CEIC, Westpac. 3 month averages.

ppt

0
Other Energy Food- primary Food - manuf Non-food manuf Total

Away from manufacturing, the services PMI has slumped by 9 index

points in three readings. The pair of observations in contractionary territory seen in September and October is the first since the early 2009. Over the history of the series, the headline measure has sunk below 50 in only two cycle phases: the GFC period and today. Historically, mid-cycle lows have been in the region of 53. The employment sub-index of the services PMI has been below 50 for four straight months, indicating that the labour market has been loosening consistently since mid year. fearful symmetrys perusal of the other key surveys (by the RBI and D&B) on business confidence, order books, capacity utilisation, price expectations, employment plans, profitability, corporate margins and the availability of finance all point to an aggregate softening in conditions. Consumer spending is also decelerating, with sales of passenger cars, two wheelers and mobile phone subscriptions all well down on the rates seen in the first half of the year.
-1

-1

-2 Jan-05

-2 Jan-07 Jan-09 Jan-11

6mth annualised. The pulse of inflation was mixed across the various subsets, with the protein basket continuing to alarm those who insist on defining it as a predominantly demand driven series (fearful symmetry argues that the long run structural argument for this position is clear but that supply is a more powerful influence on the year to year inflation trend) and elaborately transformed manufactures prices maintaining their subdued recent performance. At present, primary articles and fuel are contributing about 60% of monthly inflation, with neither category sensitive to interest rates.

And finally to inflation, which true to both market expectations and

the RBIs own thinking, remained elevated in headline terms in the October release(s). Headline WPI came in at 9.7%yr which is close enough to the year to date trend, while non-food manufacturing prices rose 7.5%yr, 0.44%mth, 3.0% 3mth annualised and 2.6%

Obligatory Chinese comparison stat: Based on the most recent

international survey data, you are 20 times more likely to run into an Indian resident at the cinema than you are their Chinese counterpart.

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.

fearful symmetry
Summary data
2011 Monthly Industrial production, of which Manufacturing Electricity Basic goods Capital goods Intermediate goods Consumer durables Manufacturing PMI (index) New orders to inventories (ratio) Services PMI (index) Composite PMI employment (index) Motor vehicle sales total %yr Two wheelers Passenger cars New cellular phone subscription mn units Domestic credit %yr Commercial Commercial nonfood Resident deposits %yr Wholesale bank financing (% res. deposits) External commercial finance* USDbn Exports %yr Imports %yr Nonoil imports %yr Trade balance USDbn Foreign direct investment USDbn Foreign portfolio investment USDbn Net foreign official assets USDbn Wholesale price index %yr Primary articles food %yr Primary articles nonfood incl. energy %yr Manufactured products excl. food %yr %3th annualised %6th annualised Policy repo rate %pa Policy reverse repo rate %pa Call money (weighted avg) %pa Cash reserve ratio % 3mth Treasury bill %pa 12mth Treasury bill %pa INR per USD Nominal effective exchange rate index^ Real effective exchange rate index^ Bombay Sensex 30 NIFTY 50 Foreign instit. investment net debt INRbn Foreign instit. investment net equity INRbn Dec 8.1 8.7 5.9 7.8 20.2 8.1 7.8 56.7 1.18 54.5 51.2 27.7 28.7 21.4 17.1 Dec 18.3 22.7 27.6 19.1 2.38 3.4 Dec 60.0 2.6 2.7 2.6 2.0 1.5 289 Dec 9.4 15.1 25.4 6.2 6.0 3.9 Dec 6.25 5.25 6.66 6.00 7.19 7.49 45.1 89.8 108.5 20,509 6,135 12 20 Jan 7.5 8.1 10.5 7.7 5.4 7.4 12.5 56.8 1.22 54.8 51.2 19.8 20.3 17.8 na Jan 16.8 21.4 23.0 16.1 2.52 2.7 Jan 57.6 23.8 28.8 6.7 1.0 1.7 294 Jan 9.5 16.7 26.6 6.5 10.5 6.9 Jan 6.50 5.50 6.92 6.00 7.23 7.59 45.4 88.4 108.4 18,328 5,506 102 48 Feb 6.7 7.5 6.8 5.6 5.7 6.3 18.2 57.9 1.26 55.9 51.2 22.1 22.9 22.0 14.7 Feb 17.7 21.7 23.0 16.6 2.46 1.4 Feb 75.7 24.7 30.1 4.9 1.3 1.6 294 Feb 9.5 11.0 34.4 7.7 14.9 9.3 Feb 6.50 5.50 6.94 6.00 7.14 7.68 45.4 87.6 106.7 17,823 5,333 13 46 Mar 9.4 11.0 7.2 6.5 14.5 3.1 14.9 57.9 1.27 55.8 52.3 19.4 18.7 25.0 14.5 Mar 17.5 21.0 21.3 16.0 2.56 5.6 Mar 51.9 19.1 3.5 4.5 1.1 0.1 296 Mar 9.7 9.4 27.3 8.5 17.8 11.8 Mar 6.75 5.75 8.99 6.00 7.31 7.64 44.9 87.6 107.0 19,445 5,834 0.1 69 Apr 5.3 5.7 6.5 7.2 6.6 3.9 1.6 58.0 1.23 55.1 51.8 23.9 27.3 13.0 11.1 Apr 17.5 21.4 22.4 18.0 2.51 2.1 Apr 34.7 20.5 12.7 12.3 3.1 3.5 303 Apr 9.7 10.7 26.9 7.0 14.8 12.6 Apr 6.75 5.75 6.33 6.00 7.52 7.76 44.3 87.5 108.3 19,136 5,750 0.2 72 May 6.2 6.3 10.3 7.5 6.2 0.1 5.1 57.5 1.22 53.0 51.6 15.6 16.5 6.2 9.5 May 17.7 21.1 22.1 17.5 2.60 2.7 May 67.8 69.9 77.7 17.3 4.7 1.6 301 May 9.6 8.3 21.4 7.2 10.4 12.6 May 7.25 6.25 7.33 6.00 8.14 8.29 44.9 86.3 106.5 18,503 5,560 23 66 Jun 9.5 11.2 7.9 7.8 38.7 1.6 1.6 55.3 1.19 54.0 51.5 14.6 15.5 5.5 8.6 Jun 19.0 21.2 20.3 18.3 2.71 3.3 Jun 46.4 42.5 47.8 7.7 5.7 0.8 304 Jun 9.5 7.6 18.4 7.7 5.9 11.7 Jun 7.50 6.50 7.33 6.00 8.19 8.29 44.8 86.3 107.2 18,846 5,647 3 46 Jul 3.8 3.1 13.1 9.5 13.8 0.5 9.0 53.6 1.06 55.3 50.2 12.4 14.7 5.7 7.6 Jul 18.0 18.9 18.2 17.4 2.82 4.2 Jul 81.8 51.5 58.1 11.1 1.1 1.6 310 Jul 9.4 8.2 15.8 7.6 2.3 8.3 Jul 8.00 7.00 7.50 6.00 8.39 8.49 44.4 87.0 108.7 18,197 5,482 26 80 Aug 3.6 4.1 9.5 5.2 4.1 1.9 5.5 52.6 1.08 52.9 49.3 15.0 18.3 1.7 5.3 Aug 18.3 19.5 20.1 18.0 2.99 3.7 Aug 44.3 41.8 39.5 14.0 2.8 1.8 316 Aug 9.8 9.6 18.2 7.7 1.8 6.0 Aug 8.00 7.00 7.84 6.00 8.39 8.31 45.3 85.0 106.3 16,677 5,001 29 108 Sep 1.8 2.1 9.0 4.5 6.8 1.5 8.7 50.4 1.02 50.5 48.9 21.9 26.5 0.8 6.5 Sep 18.4 19.5 19.3 17.4 2.4 Sep 36.4 17.2 18.2 9.8 1.8 1.1 317 Sep 9.7 9.2 14.8 7.4 0.7 3.3 Sep 8.25 7.25 7.90 6.00 8.44 8.46 47.6 82.8 103.7 16,454 4,943 17 2 Oct 52.0 1.08 49.9 18.9 0.8 3.5 19.0 Oct Oct Oct 9.7 11.1 7.7 7.5 3.0 2.6 Oct 8.50 7.50 8.16 6.00 8.65 8.68 49.2 80.8 101.6 17,705 5,327 14 17

Sources: CEIC, Westpac Economics, government agencies. *Sum of foreign currency convertible bonds and external commercial borrowings. ^Broad BIS measures.

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.

fearful symmetry
Summary data
2009 Quarterly Agriculture etc %yr Nonagriculture %yr Manufacturing %yr Utilities %yr Construction %yr Commerce & logistics %yr Finance & commercial services %yr Other services %yr Real GDP# %yr Nominal GDP %yr Implicit deflator %yr Private consumption %yr Public consumption %yr Gross fixed capital formation %yr Exports %yr Imports %yr Shares of GDP* Private consumption % Investment^ % Gross implied savings % Exports % Imports % Central fiscal situation Revenue growth %yr Expenditure growth %yr Central revenue deficit % GDP Central government debt % GDP Balance of payments Current account USDbn Merchandise balance USDbn Invisibles balance USDbn Direct investment balance USDbn Portfolio investment balance USDbn Net loans USDbn Overall balance USDbn Current account % GDP Dec08 3.3 5.8 2.6 5.0 0.7 5.4 12.3 23.6 5.8 14.8 9.0 Dec08 6.7 50.9 2.0 8.8 24.7 Dec08 61.7 34.5 30.3 22.0 30.4 Dec08 10.4 24.0 3.6 51.9 Dec08 11.9 35.0 23.1 0.7 5.8 0.4 17.9 4.2 2009 Mar09 21.1 16.4 7.4 12.9 95.7 Mar09 1.2 5.9 1.3 5.1 5.3 5.8 14.3 8.9 5.9 10.7 4.8 Mar09 6.6 2.8 0.6 4.7 6.9 Mar09 55.4 35.8 35.6 20.2 24.5 Mar09 0.3 24.0 4.8 53.8 Mar09 0.4 20.2 19.8 4.3 2.7 0.8 0.3 0.1 Jun09 11.2 8.4 20.8 18.6 93.8 Jun09 1.8 6.3 4.3 6.3 5.4 3.7 11.5 13.0 6.3 10.3 4.1 Jun09 6.6 21.3 1.0 11.8 8.3 Jun09 61.5 36.4 34.9 21.1 27.4 Jun09 5.3 30.0 5.3 53.6 Jun09 4.2 26.3 22.1 4.8 8.3 1.4 0.1 1.5 Sep09 24.2 20.0 12.1 13.4 132.1 Sep09 1.2 8.6 6.1 7.5 5.1 8.2 10.9 19.4 8.6 13.0 4.3 Sep09 8.5 37.5 0.3 14.2 16.1 Sep09 60.2 37.6 34.5 20.8 28.1 Sep09 8.3 32.2 6.1 55.5 Sep09 9.2 29.6 20.4 7.5 9.7 3.1 9.4 3.1 Dec09 39.8 33.5 3.8 2.8 143.2 Dec09 1.6 7.3 11.4 4.5 8.3 10.8 8.5 7.6 7.3 16.8 9.4 Dec09 7.0 9.6 8.7 4.9 0.6 Dec09 60.5 36.4 32.9 19.2 28.0 Dec09 1.5 19.0 5.7 55.1 Dec09 12.2 30.9 18.7 3.0 5.7 5.7 1.8 3.5 2010 Mar10 44.9 39.3 1.3 1.1 137.3 2010 Mar10 1.1 9.4 15.2 7.3 9.2 13.7 6.3 8.3 9.4 23.3 13.9 Mar10 6.6 6.2 19.2 10.6 21.1 Mar10 52.4 39.8 36.4 19.9 26.4 Mar10 6.0 15.9 5.5 52.0 Mar10 12.8 31.6 18.8 3.4 8.8 5.9 2.1 3.4 Jun10 41.2 36.3 1.6 3.2 142.8 Jun10 2.4 8.8 10.6 5.5 7.7 12.1 9.8 8.2 8.8 21.3 12.4 Jun10 9.5 6.7 11.1 9.8 15.2 Jun10 61.7 37.4 34.1 21.2 28.9 Jun10 32.2 17.3 3.8 51.5 Jun10 12.1 31.9 19.8 2.9 4.6 9.0 3.7 3.3 Sep10 41.5 34.1 5.8 3.1 150.0 Sep10 5.4 8.9 10.0 2.8 6.7 10.9 10.0 7.9 8.9 19.2 10.3 Sep10 8.9 6.4 11.9 10.7 11.6 Sep10 60.1 38.7 34.1 21.1 28.7 Sep10 34.6 13.2 3.7 50.5 Sep10 16.8 37.3 20.5 3.0 19.2 6.6 3.3 4.6 Dec10 47.5 39.6 7.2 9.2 163.5 Dec10 9.9 8.3 6.0 6.4 9.7 8.6 10.8 5.1 8.3 19.0 10.6 Dec10 8.6 1.9 7.8 24.8 0.4 Dec10 60.1 36.0 33.7 21.9 25.7 Dec10 38.7 11.0 2.9 49.7 Dec10 10.0 31.5 21.5 0.6 6.3 6.3 4.0 2.3 2011 Mar11 50.1 41.1 9.5 8.3 171.2 2011 Mar11 7.5 7.8 5.5 7.8 8.2 9.3 9.0 7.0 7.8 17.2 9.5 Mar11 8.0 4.9 0.4 25.0 10.3 Mar11 52.6 37.8 36.6 23.1 27.0 Mar11 38.7 17.0 3.4 48.8 Mar11 5.4 29.9 24.5 0.6 0.2 5.9 2.0 1.2 Jun11 41.4 33.4 4.4 3.8 183.3 Jun11 3.9 7.7 7.2 7.9 1.2 12.8 9.1 5.6 7.7 16.7 9.0 Jun11 6.3 2.1 7.9 24.3 23.6 Jun11 60.5 37.8 34.5 24.3 33.0 Jun11 2.2 13.9 4.9 49.1 Jun11 14.2 35.5 21.3 7.2 2.5 6.4 5.4 3.3 Sep11 39.8 30.6 25.0 2.5 143.6

Corporate sector (net balances) RBI survey business conditions RBI survey financial conditions RBI survey capacity utilisation level RBI survey profit margins Dun & Bradstreet optimism index

Sources: CEIC, Westpac Economics, government agencies. # Production basis at factor cost. * Expenditure basis at market prices. ^ Includes inventories & valuables.

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.