Indian Economy: Outlook and Prospects : FY12 and FY13
In January 2012, CARE Ratings released its projections of various economic variables for 2012 and 2013. The Report projects that India’s GDP growth in FY12 will be 7%, which is likely to rise to around 7.5% in FY13 under certain assumptions made relating to the global economy and domestic policy responses. Inflation on the other hand is to moderate to 5% in FY13 based on a good harvest and stable global commodity prices.
The projection for the fiscal deficit for FY12 has been placed at 5.5% which is expected to range between 5-5.5% in FY13 mainly due to pressure on the expenditure side. The RBI is expected to lower interest rates in the course of the year, with the repo rate coming down by 100-150 bps. The outlook further expects the rupee to remain volatile as euro conditions will remain in flux while the domestic current account deficit will be under pressure at 3% of GDP which will still be an improvement over the 3.5% deficit expected in FY12.
Speaking on this outlook, Mr. D R Dogra, MD & CEO, CARE Ratings said, “We do expect the economy to recover gradually in FY13 which is encouraging. However, the challenges remain on the policy fronts, and I think that the fiscal deficit target for FY13 will hold the clue to how things pan out during the year. Given that investment has been slack in FY12, we do hope that it picks up so that the growth objective is achieved. We would be expecting the government to come up with some big plans in the infrastructure space. A robust growth and investment environment is necessary for maintaining corporate ratings. “
Indian Economy Data and Statistics for 2012 and 2013
The economic conditions in the country in the current fiscal have been challenging with inflation being the major factor driving economic policy. This has had a major impact on other economic variables with official projections being modified downwards along the year. Policy formulation has become even more difficult with the volatility witnessed in the forex market, where the rupee has tended to move downwards. The prospects for FY12 may be drawn based on the present combat against inflation, slowing down of investment, pressure on budget deficit, widening current account balance, depreciating rupee and uncertain capital markets. Expectations for FY13 are based on certain perceptions on the state of the global economy as well as the expected policy of domestic authorities.
About Indian Economy Prospects for FY12
GDP growth is to be driven mainly by the services sector which excludes any stimulus from the part of the government. Overall growth is expected to be in the range of 7% in FY12. This is creditable and would still be one of the highest in the world with only China, Argentina, and Turkey being ahead.
Farm growth at around 3% will be major comfort for GDP growth and will also mean a second successive harvest after the drought of FY10. Production is to be boosted mainly by cereals such as rice and wheat and cash crops such as cotton, jute and sugarcane. This has provided both demand for non-farm goods as well as supplies for the manufactured food products which has in turn helped growth of industry.
Industrial production (including construction), which was to grow in the region of 8-9% for the year would be fairly subdued even from the 7.1% projection made by the PMEAC in July. With fairly volatile numbers so far this year and negative growth in October, overall projections have been lowered to the range of 5%, which will still mean a substantial recovery in the last 4 months of the year, which on a high base, will be an achievement. Major risks in this area are in the mining and capital goods sector. For the former, policy action is required while for the latter, a revival in investment is called for. Absence of affirmative action in areas such as reforms in mining, land, insurance, pensions, banking, taxation etc. along with high interest rates have come in the way of investment growth. While it is expected that we have reached the end of the interest rate cycle, the progress on reforms is expected to be tardy till the first quarter of FY13.
The service sector, with a weight of around 60% in GDP will be the chief driver with growth of around 9% during the year. Growth is expected to be broad based with only the government sector showing a slowdown.
The fiscal deficit for FY12 will not meet the Budget’s target of 4.6% of GDP and would be higher on account of revenue slippages and excess expenditure. Based on the revenue loss from indirect taxes announced in mid -2011 as well as the higher government borrowings of over Rs 90,000 cr announced by the RBI for the year, the ratio is to slip towards the 5.5% mark, assuming that there are no further shocks.
The question marks remain over the progress of the disinvestment programme of Rs 40,000 cr (only Rs 1,444 cr has been mobilized until now) and subsidy bill which has already overshot the budgeted amount of around Rs 145,000 cr. While there are mechanisms being put in place for enabling the disinvestment programme, it is uncertain as to what could be the level of success. Hence, the deficit level of 5.5% of GDP is a more conservative estimate, which is subject to an increase if these assumptions are violated. Also it should be noted that statistically the deficit ratio is being supported by a highe r denominator as the overall growth of GDP at current market prices would be between 2-3% higher than was envisaged at the time of presentation of Budget 2011-12.
Inflation as given by the WPI will move towards the 7% mark earlier than expected and could touch 6-6.5% by March end on a point to point basis guided by negative food inflation. The present trend of negative food inflation is being assisted by the base year effect which will wane by the end of the year. However, pressure will continue to be exerted by core and fuel inflation as the international crude prices will remain at the existing level which together with a weak rupee will exert pressure on prices. The government at best will not increase petro product prices this financial year and take on the additional cost aa part of the subsidy bill.
Monetary indicators look to be weaker this year with growth in credit being 16% and deposits 18%. Growth in deposits is well ahead of that in credit and will continue to be so for the rest of the year. Surplus funds are being deployed in government paper thus enabling the government’s borrowing programme.
Given the uncertainty over inflation, the RBI is unlikely to touch rates till March end even if the inflation number declines to 6-7% before that as core inflation is a concern and the central bank has to be certain that inflation will remain at lower levels before invoking an about turn in policy.
While a CRR cut is possible to induce liquidity to ensure that the borrowing programme of the government goes through, the RBI may prefer to use OMOs as a CRR cut is viewed as being rather permanent, as a part of policy stance and reducing the same could send contradictory messages to the markets. The RBI has been following an anti-inflationary policy stance since early 2010.
Liquidity will continue to be under pressure this year since, with credit growth also picking up to support commerce there will be additional demand from both the government and industry. This will keep GSec yields steady and that on 10 -years will range between 8.2-8.5%. More borrowings will increase supply of paper that will depress prices, and consequently move yields upwards.
External sector outlook
The external account will be under pressure till March 2012. The trade deficit has been widening with growth in exports slowing down while imports continue to increase at a steady pace. This year so far, remittances and software flows have provided support to the current account. With these flows continuing to increase, albeit at a gradual pace, the current account deficit will in the range of 3.5% of GDP this year.
Capital receipts have in the past provided support to the current account deficit. However, this year, FII flows have been just $ 6 bn till December and concentrated in debt. This number is not likely to improve substantially and would at best be around $ 10-12 bn by the end of the year. FDI however is the major supporting factor here, with around $ 20 bn coming in the first 7 months of the year. The target of around $ 30 bn is likely to be achieved.
In case of ECBs, the target of over $ 35 bn is unlikely to be met, thus leading to pressure on the overall balance of payments and reserves. Given the pressure on the balance of payments, the rupee will continue to be under pressure in the range of Rs 50 -52/$ till March. However, any major shock in the global economy would change this range.
Outlook for 2012
The outlook for 2012 and further till March 2013 will be based on two sets of factors.
The world economy is in a state of flux with the euro rescue package still being implemented. The recent downgrading of 9 nations has further added to the uncertainty with a possibility of further default problems in Greece resurfacing. Assuming that there are no further failures in the euro region and the rescue packages are to be implemented, there would be a tendency for countries to resort to fiscal austerity which in turn will slow down these economies. Therefore, overall growth here will be muted for a second successive year, and at around 0.5-1% compared with 1.5% in 2011. This would also be contingent on strong recovery in Germany and France. While ECB could lower rates in the course of the year by up to 50 bps, it is unlikely to have a perceptible impact given the fiscal concerns in most of these nations . This said, markets will continue to be volatile as the debt ridden nations will continuously be under stress to service their debt which in turn will affect sentiment that will be reflected mainly in the exchange rate with the dollar.
The USA, which will probably continue its upward movement from around 1.8-2% in 2011 to between 2-2.5% in 2012, will not be able to propel the world economy on its own given that the emerging markets will also be under strain especially so on account of high commodity inflation which has invoked stringent monetary measures in these countries. Therefore, the overall global performance, which will have a bearing on trade flows and capital movements, is likely to at best be at present levels with marginal improvement towards the end of the year.
Domestic economic developments will be largely driven by three sets of policy responses: Monetary policy, Fiscal stance, and, Economic reforms.
However, the starting point will be the inflation direction as it has an overbearing impact on all policies. Inflation should be under control during the year at around 5% assuming that global commodity prices stay stable, in particular oil. With the global economy moving at a slow rate, this is a reasonable assumption which in turn will exert some control over imported inflation. The other caveat is a normal monsoon as this is one factor which can tilt the scales. Further, the Ministry of Petroleum’s view on administered fuel prices will also have a bearing on inflation as these products have a direct weight of around 7.5% in the WPI and also influence prices of other products, especially food products through transport cost. Keeping this factor as a constant, the following is the outlook for the Indian economy in FY13.
A. GDP growth to move upwards of the present rate of 7% towards the 7.5% mark
a. Agriculture to pose a modest 2-3% growth which will come over two very good years of farm production. The base year effect will play a leading role in the final outcome.
b. Industrial growth will start moving up based more on consumption rather than investment demand. The impact of high interest rates and inflation on investment first witnessed in FY12 will continue to be a downside risk to industrial growth and this will slow down the recovery process. A larger role of the government is envisaged in the new fiscal which will provide a stimulus to industrial growth. Overall industrial growth would be in the 7-8% region in FY13 based on three factors, the absence or delay of which will upset these projections. In fact growth would be more in the 6-7% region in case of such slippage.
i. Base year effect provides a boost
ii. Interest rates are rolled back
iii. Government spending also increases
c. Services sector will continue to be the engine to growth with a lead of 9% which will be supported by both the banking sector, retail space, transport and communication and more importantly the social and community services, which means more government spending.
B. The government will have to weigh the overall external and internal environment while formulating the Budget. While the external environment is quite nebulous, the domestic economy deserves a push that can be provided by the government. It is expected that the focus will be on project expenditure this time to provide a boost to the infrastructure sector so that the linkages are forged. The deficit will be at between 5.0-5.5% of GDP based on assumptions of moderate inflation and growth for revenue targeting. A review of the anti-poverty programme as well as implementation of the Food Security Bill will pressurize resources and hence lowering the fiscal deficit level further will be a challenge. Also the disinvestment programme of the government will have to be scaled down given the uncertain times on the bourses.
C. Monetary policy will tend to be cautiously open with the repo rate to be lowered sequentially by 100-150 bps during the course of the year. The trigger would depend on when the core inflation number dips over the next three months. CRR cut would be invoked only in case of tight liquidity conditions prevail and would be in conjunction with the interest rate stance. Given that demand for funds is typically less compelling in the first quarter of the year, it would be considered only in case of a liquidity crunch in the second or third quarter of the year and will not be contrary to the interest rate stance.
D. GSec yields will tend to move downwards, and the 10-year rate would move in the range of 8.0-8.5% mark depending on overall liquidity conditions as well as the fiscal deficit. Liquidity will continue to be stable with some pressure and RBI intervention will be necessitated as larger government borrowing along with increase in domestic credit will put pressure on the banking system.
E. The rupee would be impacted by both global exchange rate movements as well as forex inflows. The dollar would tend to be stable vis-à-vis the euro, but given lower demand conditions in this region, there could be a tendency for the dollar to move in the range of $ 1.25-35/euro which will cause volatility from this end. Two factors will be at work: the nebulous euro region climate will make the euro weaker, while the recovery in USA accompanied by the growing current account deficit can make the dollar weaken. The current account deficit may be targeted at 3% of GDP with exports reviving, though the slowdown in euro region will continue to pressurize the deficit. Support through remittances and software would be required to prop up the external balance. While FDI will continue to increase FII flows will be marginally better given a recovery in the world economy. This will help to prop up the domestic stock markets too. The rupee will be in the range of Rs 48-52/$ during the year.
F. Concerns will remain on external debt and its composition as the debt to reserves ratio has exceeded 1 after a long time. Debt service especially that of short term loans will continue to be a concern going ahead.
Therefore, while a gradual recovery is expected in the economy in FY13, it is contingent on various other assumptions holding. More importantly, policy action would be the key. While easing of rates and liquidity will be in accordance with broader monetary policy goals of inflation, the government’s deficit will be critical as it will have to be a growth oriented budget, which gives incentives where it is needed through taxes, spends money on infrastructure to provide a stimulus and also meets its own social commitment expenditures.
This report is prepared by the Economics Division of Credit Analysis & Research Limited [CARE]. CARE has taken utmost care to ensure accuracy and objectivity while developing this report based on information available in public domain. However, neither the accuracy nor completeness of information contained in this report is guaranteed. CARE is not responsible for any errors or omissions in analysis/inferences/views or for results obtained from the use of information contained in this PDF report and especially states that CARE (including all divisions) has no financial liability whatsoever to the user of this downloaded PDF report.