CRISIL EconomyInsight

India: 2011-12 Macroeconomic Outlook Revision

December 2011

A Study by CRISIL Center for Economic Research

CRISIL EconomyInsight
India 2011-12 Macroeconomic Outlook Revision
An explanatory note

Real Growth (%) Inflation (%) Interest Rate (%) Exchange Rate Fiscal deficit

Agriculture Industry Services Total GDP WPI Average 10-year G-sec (March-end) Rs/US$ (March-end) % of GDP

2011-12 (December 2011) 3.8 4.5 8.9 7.0 9.2 8.5 48.0 5.5

2011-12 (October 2011) 3.2 6.5 9.2 7.6 9.1 8.3-8.5 45.0-46.0 5.2

2010-11 6.6 7.9 9.4 8.5 9.6 7.8 44.8 5.1

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

Gross Domestic Product (GDP): Forecast revised down to take into account a mild recession in Eurozone in the first half of 2012 and a moderate recovery thereafter. This will adversely impact industry and consequently services. o o o Agriculture growth revised up on account of normal monsoon resulting in better sowing during Kharif and improved prospects for Rabi crop. Industrial growth revised down due to weak exports led by slipping global demand, and limited fiscal bandwidth. Services growth revised down with slowing industry expected to reduce demand for services

Inflation (WPI): Forecast revised up due to the continued weakening of rupee which has exerted pressure on imported component of inflation and a possibility of further fuel price pass-through into domestic economy, given the limited fiscal room to absorb subsidies. 10 year G-sec yield: Repo rate (the floor of the yield) to remain at 8.5 per cent till April 2012 and term premium not expected to be significant as RBI takes measures to alleviate liquidity shortage. Exchange Rate (Rs/US$): A mild recession in the first half of 2012 in Eurozone to lower portfolio inflows compared to that expected under our earlier assumption of avoidance of Eurozone recession. However, expectation of a moderate recovery thereafter will increase portfolio inflows by March 2012 relative to the current levels, given the forward-looking financial markets. Fiscal deficit: Forecast revised upwards to account for significant under-budgeting of subsidies, difficulty in completing the disinvestment programme, and likelihood of further increase in government borrowing program if expenditure under supplementary demands for grants is entirely approved. This, given the slow growth in revenue collections, indicates a tighter fiscal position.

CRISIL Research lowers GDP growth forecast to 7.0 per cent for 2011-12
CRISIL Research has lowered Indias GDP growth forecast for 2011-12 to 7.0 per cent from the earlier forecast of 7.6 per cent. While we had anticipated the growth dampening impact of rising interest rates and the slowdown in advanced countries, the European macroeconomic scenario has worsened considerably in recent weeks, thus having deeper implications for Indias growth. According to Standard & Poors, Eurozone growth would weaken sharply in the fourth quarter of 2011 and the region will remain in recession in the first half of 2012. Hence, our earlier assumption under the base-case scenario that a double dip will be averted in Eurozone does not hold any more. A potential recession in Eurozone would affect Indias growth by adversely impacting exports and foreign investments during the second half of 2011-12 as well as in 2012-13. Eurozone accounts for nearly 15 per cent of Indias merchandise exports. In addition, Indias major IT/ITeS companies have a significant dependence on Eurozone. In the past, business cycles in India and in Eurozone have largely moved in tandem. (Figure 1). In addition to worsening of Eurozone economic prospects, the lack of fiscal space to provide direct stimulus to the economy and lack of consensus on domestic policy reforms which continue to hurt investment climate, has led to the downward revision in our macroeconomic outlook. This is our third downward revision in growth outlook for this year. In October 2011, we had scaled down growth forecast to 7.6 per cent for 2011-12 from 7.7-8.0 per cent released in May 2011. Our original forecast for GDP growth was 8.3 per cent for the current fiscal year released in January 2011. Figure 1: Business cycle co-movement
Real GDP growth, y-o-y%

12 9 6 3 0 -3 -6

Euro Area

India

Source: World Economic Outlook database, IMF

Average growth during the first half of the 2011-12 stands at 7.3 per cent. We expect growth in the second-half to be around 6.7 per cent, aided in part by a low base. A sharp downward revision in industrial growth to 4.5 per cent from our earlier forecast of 6.5 per cent is largely responsible for scaling down the overall GDP growth forecast (Figure 2). Within the industrial sector, manufacturing growth has been revised down considerably due to a sharper-than-expected slowdown in domestic and global demand.

The slowdown in industrial sector is expected to spill over to services via the linkages between the two. In addition, community and social services growth is unlikely to provide support in the form of direct fiscal

2011 (P)

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

CRISIL EconomyInsight
stimulus, as seen in the second half of 2008-09. The forecast for service sector growth has therefore been revised downwards to 8.9 per cent from 9.2 per cent. A deceleration in private consumption growth, which is now expected to be around 6.0 per cent, will adversely impact growth in service sectors such as trade, hotels and banking services. On the positive side, we have raised agriculture sector growth forecast to 3.8 per cent from the previously estimated 3.2 per cent favoured by the timely and steady progress of monsoon which enabled better sowing during the Kharif season and improved prospects for the Rabi crops. Figure 2: Real GDP growth, sector-wise
Real GDP growth, y-o-y%

10.1 8.0 7.9 9.4 8.9

8.5 8.0 7.0 6.6

4.5 3.8 0.4 FY10 FY11 GDP FY12F FY10 FY11 FY12F FY10 FY11 Industry FY12F FY10 FY11 Services FY12F

Agriculture

Source: CSO and CRISIL Research

WPI inflation forecast revised upwards to 9.2 per cent for 2011-12
Despite our outlook of lower growth, we have revised our forecast on WPI inflation for 2011-12 slightly upwards to 9.2 per cent from the earlier forecast of 9.1 per cent. This is because the continuous weakening of the rupee has exerted additional pressure on the imported component of inflation. We now expect the rupee to end the fiscal year at a lower value of Rs 48 per US$ as compared to the earlier forecast of Rs 45-46 per US$ (refer the section on exchange rate outlook). This will keep inflation at higher levels than expected earlier. Upward revision in inflation also takes into account the continuing firmness in global crude oil prices which if continues, could result in further fuel price pass through into domestic economy, since there is limited fiscal room to absorb further subsidies. Despite raising the average inflation forecast for 2011-12, we expect it to head down from the current levels by March 2012. A normal monsoon and hence a good harvest has kept food inflation in check. Also, the impact of monetary tightening on domestic demand growth aided by a base effect will help in moderating inflation going ahead. In addition, recession in Eurozone could bring down global food and commodity prices, and help lower inflation to RBIs year-end projection of around 7.0 per cent

Table 1: Persistence of inflation

2008-09 WPI Total Food Core Fuel 8.1 9.1 5.8 11.7 2009-10 3.6 15.2 0.2 -1.7 2010-11 9.6 15.8 6.1 12.3 April to October11 9.6 9.2 7.5 13.2

Source: Ministry of Finance and CRISIL Research

10-year G-sec yield to be around 8.5 per cent March-end 2012

CRISIL Research now expects the 10-year government security (G-sec) yield to end 2011-12 at 8.5 per cent compared to our earlier range of 8.3-8.5 per cent, released in October 2011. This revision is based on two factors: Repo rate sets the floor for 10-year G-sec. After we released our previous forecast in early October, the RBI raised the repo rate to 8.5 per cent. We expect it to remain at this level until March-end 2012. The demand and supply of G-sec which determines the term premium (compensation for the risk of holding the longer-term instrument) over the floor will not be significant. This is because RBI is expected to continue to undertake requisite steps in coming months to alleviate liquidity shortage in the banking sector. This, along with preference for risk-free investments by investors in current uncertain environment, expectation that the rate hike cycle has peaked, and moderating inflation, would cap 10year G-sec yield at 8.5 per cent, despite higher government borrowing requirement. The 10-year benchmark G-sec yield is, by definition, a weighted average of the current one-year rate (in turn guided by the repo rate Figure 3) and nine one-year forward rates. Forward rates depend on the extent of term premium over and above the floor. Term premium is determined by the interaction between the supply and demand for these securities. While the higher supply of securities lowers the price of 10-year G-sec and raises its yield, higher demand raises the price of the securities and lowers the yield. Figure 3: Term premium (10-year G-sec yields and repo rate), year-end (%)
% 8.50

7.00 Term Premium 5.50

4.00 Mar -05 Jan-05 Mar -06 Jan-06 Mar -07 Jan-07 Mar -08 Jan-08 Repo Mar -09 Jan-09 10 year Mar -10 Jan-10 Mar -11 Jan-11

Source: CCIL and CRISIL Research

CRISIL EconomyInsight
Figure 4: 10-year G-sec yields, year-end (%)
% 8.8 8.5

8.1 7.8

8.0

7.4 FY10 FY11 FY12F

Source: CCIL and CRISIL Research

Fiscal deficit to GDP to rise to 5.5 per cent in 2011-12

CRISIL has revised its fiscal deficit forecast to 5.5 per cent of GDP for 2011-12 compared to the previous estimate of 5.2 per cent (released in October 2011) and the governments estimate of 4.6 per cent (Figure 5). Our initial forecast had accounted for some under budgeting of subsidies such as oil, difficulty in completing the disinvestment programme of Rs 400 billion and a sudden increase in the government borrowing program by Rs 528 billion to meet the fiscal deficit. In addition to the above, the current revision takes into account the Rs 979 billion (Rs. 631.8 billion in November 2011) of supplementary demand for grants (net cash outgo of Rs. 658.6 billion) to meet the Centres expenditure. If this amount is entirely approved by the Parliament, it will push the governments total expenditure by about 7.8 per cent over budgeted levels. Major heads under the second supplementary demand for grants (sought in November 2011) include: Rs 300 billion as compensation for the under-recoveries of oil marketing companies, over and above the Rs 15.9 billion compensation sought in August 2011. Rs 137.8 billion, largely towards compensation for fertilizer subsidies. The government has already incurred about 54.1 per cent of the budgeted expenditure during April to October 2011 as compared to 50.8 per cent during the corresponding period in 2010. Moreover, the revenue position of the government appears fragile. On the revenue side, only 45.5 per cent of the total budgeted receipts have been accrued during April to October 2011 compared to 57.1 per cent during the previous year. Lower-thanbudgeted disinvestment revenue as well as low growth in tax collections is expected to keep fiscal position tight. Of Rs 400 billion of disinvestment revenue budgeted in 2011-12, only Rs 11.4 billion of proceeds have accrued at present from the sale of the governments stake in Power Finance Corporation. Weak market conditions further reduce the chances of significant divestments during this fiscal. Slowing industrial output and lower growth outlook for the second half of current fiscal could have further negative impact on tax collections. During April to October 2011, net tax revenue collections were at 43.9 per cent of budgeted levels compared to 48.3 per cent in the previous year.

The tight revenue position and increase in expenditure yield a sharp upward push to absolute fiscal deficit. This coupled with a corresponding downward revision in our nominal GDP estimates to aorund 16.2 per cent (from 16.7 per cent estimated earlier) places the fiscal deficit to GDP ratio at around at 5.5 per cent for 2011-12. Figure 5: Fiscal deficit to GDP (%)
6.5

6.0

December 2011 5.5 October 2011 February 2011 5.0 2009-10 2010-11 2011-12 F

Note: February and October 2011 are CRISIL Researchs earlier forecasts Source: Ministry of Finance and CRISIL Research

Rupee to end 2011-12 around 48.0 per US$

In the base case scenario, CRISIL Research now expects rupee to settle around Rs 48 per dollar by March-end 2012 and assigns 50 per cent probability to this event. This is based on the assumption that Eurozone will suffer a mild recession in the first half of 2012 and a moderate recovery thereafter, as projected by Standard & Poors. In this scenario the supply of dollars from portfolio flows will be lower than in our earlier assumption of avoidance of recession Eurozone. Hence, we have moved our Rupee/US$ forecast down from our earlier forecast of Rs 45-46 per US$. The financial markets are forward looking and anticipate changes in real economy in advance. If the European scenario of mild recession pans out as expected currently and recovery resumes in the second half of 2012, portfolio inflows to India would improve in anticipation. This will help improve the supply of US$ towards March 2012 and appreciate the rupee to 48 from the current levels of 51.5. This assumes there will be no adverse shock leading to a pickup in demand for US dollars (like increase in commodities and oil prices from current levels). If this assumption is breached and problems in Eurozone intensify, rupee can even settle above 50 per US$ (30% probability). We now assign a lower probability of 20 per cent to rupee touching 46 per US$ by March-end 2012. A 30 per cent probability is assigned to rupee touching or even exceeding Rs 50 per dollar in March-end 2012. The reasoning for these alternative scenarios is laid out in Table 2. During November 2011, the rupee touched a high of 52.7 to a dollar, higher than the previous peak of 52.1 that was seen in March 2009. The rupee also witnessed sharp volatility during the month fluctuating between Rs. 49.1 to 52.7 to a dollar. The supply of dollars into India reduced in November following a net FII outflow

CRISIL EconomyInsight
of US$ 0.6 billion, led by further diminishing risk appetite of foreign investors in the wake of a worsening global outlook. However, the quantum of outflows has not been very high when compared to the foreign capital flight seen in the period between October 2008 and March 2009 (Figure 6) when rupee had depreciated by a similar magnitude. In addition to the muted FII activity, slowing export growth would further reduce the supply of US$ into India. The demand for dollars has increased because corporate India is facing repayment pressures on its foreign borrowings in addition to the increasing cost of its imports, especially oil. The repayment of Indias overall short-term debt, at US$ 88 billion in 2011-12, is 25 per cent higher over 2010-11 levels. In the current environment of uncertainty, the rollover of trade credit will be difficult, and getting fresh trade credit will also pose a challenge in view of the rising risk aversion in advanced countries. The corporate debt repayment pressure will continue to remain high in 2012-13. However, in the base case scenario, we assume that there will be no significant advance purchases of US$ for debt repayments due in early 2012-13. If that happens, then demand for US$ will increase and will exert further pressure on the rupee. If international oil and commodity prices soften on account of the global economic slowdown, Indias import bill would rise at a slower pace going ahead, thereby relieving pressure on demand for the US$. Moreover, in the event that European leaders display political dynamism and Eurozone situation is contained to a mild recession in the first half of 2012, the FIIs could return to the Indian markets in 2012, thus increasing the supply of US$.

Figure 6: Net FII inflows and Exchange rate

USD bn 3.00 2.00 1.00 0.00 -1.00 -2.00 -3.00 -4.00 -5.00 42.85 Aug Sep Oct 46.0 Net outflow (Aug to Nov) = US$ 5.11 bn Re fall (Aug to Nov) = 14.7 per cent Nov Dec Jan Feb Mar Apr Aug Sep Oct Nov 45.12 Net outflow (Aug to Nov) = US$ 0.52 bn Re fall (Aug to Nov) = 12.2 per cent 44.0 49.17 50.62 50.22 50.0 Re / USD 52.0

48.0

42.0 Dec 2011-12 Re / USD on right scale Jan Feb Mar Apr

2008-09 Net FII inflow

Source: CCIL and CRISIL Research

Table 2: Exchange Rate scenarios

Scenario 1 Rupee per US$ by March-end 2012 Probability Global Economy 46 20% Credible solution to the EU crisis Indian Economic growth Demand for US$ Imports 7.60% High oil prices, relatively robust growth Scenario 2 48 50% Short-term resolution for EU crisis 7.00% With stable oil price, secular rise in import bill Corporate debt repayment No advance purchases of US$ for early FY13 repayments No advance purchases of US$ for early FY13 repayments Scenario 3 >50 30% Deepening of the EU crisis, disorderly default <7% Correction in oil price, domestic slowdown will lower import bill Panic purchases of US$ purchases for repayments due in early FY13 Supply of US$ Exports Marginal pick up in export growth FII Sharp rise in inflows Anticipated export slowdown Outflow stops, marginal inflows FDI ECBs Stable Stable Stable Moderating Stable Temporary credit freeze Sharper slowdown in export Increased outflow

Remittances Source: CRISIL Research

Marginal increase

Stable

Marginal decline

About CRISIL Limited CRISIL is a global analytical company providing ratings, research, and risk and policy advisory services. We are India's leading ratings agency. We are also the foremost provider of high-end research to the world's largest banks and leading corporations. About CRISIL Research CRISIL Research is the countrys largest independent and integrated research house with strong domain expertise on Indian economy, industries and capital markets. We leverage our unique research platform and capabilities to deliver superior perspectives and insights to over 1200 domestic and global clients, through a range of research reports, analytical tools, subscription products and customised solutions. Disclaimer
CRISIL Limited has taken due care and caution in preparing this Report. Information has been obtained by CRISIL from sources, which it considers reliable. However, CRISIL does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. CRISIL Limited has no financial liability whatsoever to the subscribers / users / transmitters / distributors of this Report. The Centre for Economic Research, CRISIL (C-CER) operates independently of and does not have access to information obtained by CRISIL's Ratings Division, which may in its regular operations obtain information of a confidential nature that is not available to C-CER. No part of this Report may be published / reproduced in any form without CRISIL's prior written approval.

CRISIL Privacy Notice

CRISIL respects your privacy. We use your contact information, such as your name, address, and email id, to fulfill your request and service your account and to provide you with additional information from CRISIL and other parts of The McGraw-Hill Companies, Inc. you may find of interest. For further information, or to let us know your preferences with respect to receiving marketing materials, please visit www.crisil.com/privacy. You can view McGraw-Hills Customer Privacy Policy at http://www.mcgrawhill.com/site/tools/privacy/privacy_english Last updated: 31 March, 2011

Analytical Contacts: Dharmakirti Joshi Chief Economist Email: djoshi@crisil.com Phone: +91 22 33428043 Sunil K Sinha, Senior Economist Vidya Mahambare, Senior Economist Parul Bhardwaj, Economist Dipti Saletore, Economist Anuj Agarwal, Economist Aindrila Roy Chowdhury, Economist

Media Contacts: Mitu Samar Head, Communications and Brand Management Email: msamar@crisil.com Phone: +91 22 3342 1838 Priyadarshini Roy Communications and Brand Management Email: proy@crisil.com Phone: +91 22 3342 1812

CRISIL Limited CRISIL House, Central Avenue, Hiranandani Business Park, Powai, Mumbai- 400 076, India www.crisil.com

CRISIL Ltd is a Standard & Poor's company