CRISIL Macro Outlook Revision_Dec 2011

8/3/2019 CRISIL Macro Outlook Revision_Dec 2011

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CRISIL EconomyInsight

December 2011

A Study by CRISIL Center for Economic Research

India: 2011-12 Macroeconomic Outlook Revision


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India 2011-12 Macroeconomic Outlook Revision

An explanatory note

2011-12 2011-12

2010-11(December

2011)

(October

2011)

Real Growth (%)

Agriculture 3.8 3.2 6.6

Industry 4.5 6.5 7.9

Services 8.9 9.2 9.4

Total GDP 7.0 7.6 8.5

Inflation (%) WPI Average 9.2 9.1 9.6

Interest Rate (%) 10-year G-sec (March-end) 8.5 8.3-8.5 7.8

Exchange Rate Rs/US$ (March-end) 48.0 45.0-46.0 44.8

Fiscal deficit % of GDP 5.5 5.2 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 inthe first half of 2012 and a moderate recovery thereafter. This will adversely impact industry andconsequently services.

o Agriculture growth revised up on account of normal monsoon resulting in better sowing during Kharif andimproved prospects for Rabi crop.

o Industrial growth revised down due to weak exports led by slipping global demand, and limited fiscalbandwidth.

o 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 onimported 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 termpremium 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 inflowscompared 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 thecurrent levels, given the forward-looking financial markets.

Fiscal deficit: Forecast revised upwards to account for significant under-budgeting of subsidies, difficulty incompleting the disinvestment programme, and likelihood of further increase in government borrowing programif expenditure under supplementary demands for grants is entirely approved. This, given the slow growth inrevenue collections, indicates a tighter fiscal position.


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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 forecastof 7.6 per cent. While we had anticipated the growth dampening impact of rising interest rates and theslowdown 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 foreigninvestments 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 tothe 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

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-halfto 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. Inaddition, community and social services growth is unlikely to provide support in the form of direct fiscal

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010

2011

(P)

Euro Area India

Real GDP growth, y-o-y%


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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 whichenabled better sowing during the Kharif season and improved prospects for the Rabi crops.

Figure 2: Real GDP growth, sector-wise

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 upwardsto 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 ifcontinues, 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 byMarch 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

8.0

8.5

7.0

0.4

6.6

3.8

8.0 7.9

4.5

10.1

9.4 8.9

FY10 FY11 FY12F FY10 FY11 FY12F FY10 FY11 FY12F FY10 FY11 FY12F

GDP Agriculture Industry Services

Real GDP growth, y-o-y%


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Table 1: Persistence of inflation

2008-09 2009-10 2010-11 April to October11

WPI 8.1 3.6 9.6 9.6

Total Food 9.1 15.2 15.8 9.2

Core 5.8 0.2 6.1 7.5

Fuel 11.7 -1.7 12.3 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 centcompared 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, theRBI 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 ofholding 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 10-

year 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 turnguided by the repo rate Figure 3) and nine one-year forward rates. Forward rates depend on the extent ofterm 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 (%)

Source: CCIL and CRISIL Research

4.00

5.50

7.00

8.50

Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

%

Repo 10 year

Term Premium

Mar -05 Mar -06 Mar -07 Mar -08 Mar -09 Mar -10 Mar -11


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Figure 4: 10-year G-sec yields, year-end (%)

Source: CCIL and CRISIL ResearchFiscal 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 previousestimate 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 inNovember 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 Rs15.9 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 ofthe 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-than-

budgeted 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 haveaccrued 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 furthernegative 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.

7.8

8.0

8.5

7.4

8.1

8.8

FY10 FY11 FY12F

%


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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 (%)

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-end2012 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 theEuropean 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 percent 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 52.1that 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

5.0

5.5

6.0

6.5

2009-10 2010-11 2011-12 F

December 2011

October 2011

February 2011


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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 foreignborrowings 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 casescenario, 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 therupee.

If international oil and commodity prices soften on account of the global economic slowdown, Indias importbill 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

Source: CCIL and CRISIL Research

42.85

49.17

50.22

45.12

50.62

42.0

44.0

46.0

48.0

50.0

52.0

-5.00

-4.00

-3.00

-2.00

-1.00

0.00

1.00

2.00

3.00

Aug Sep Oct Nov Dec Jan Feb Mar Apr Aug Sep Oct Nov Dec Jan Feb Mar Apr

2008-09 2011-12

Re / USDUSD bn

Net FII inflow Re / USD on right scale

Net outflow (Aug to Nov)= US$ 5.11 bn

Net outflow (Aug to Nov)= US$ 0.52 bn

Re fall (Aug to Nov)= 14.7 per cent

Re fall (Aug to Nov)= 12.2 per cent


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Table 2: Exchange Rate scenarios

Scenario 1 Scenario 2 Scenario 3

Rupee per US$ by March-end 2012 46 48 >50

Probability 20% 50% 30%

Global Economy Credible solution to the

EU crisis

Short-term resolution

for EU crisis

Deepening of the EU

crisis, disorderly default

Indian Economic growth 7.60% 7.00%


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CRISIL Macro Outlook Revision_Dec 2011

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