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�� Growth prospects of global economy have improved
The global economy is characterised by strengthening recovery in the US and
robust economic momentum in the emerging markets (EM). The US economy
expanded 2.6% Q-o-Q (annualised) in Q3CY10, up from 1.6% in the previous
quarter, but lower than 3.7% in Q1CY10. Improvement in private consumption
and rise in inventories contributed strongly to the GDP growth in Q3. Fed’s fresh
round of quantitative easing (QE2, involving purchase of US Treasuries up to USD
600 bn) has reduced the downside risks to the economy, while the extension of
tax cuts (which were due to expire in January 2011, and therefore could have
been a huge drag on the economic recovery), have improved the economy’s
outlook for 2011. High frequency data such as retails sales, ISM manufacturing,
jobless claims have all shown improvement. Accordingly, growth projections for
US economy for 2011 have been revised higher. However, weakness in the US
housing market persists, unemployment rate remains stubbornly high at ~10%,
core inflation is at record low and the private sector continues to de-leverage.
Accordingly, the Fed is likely to remain ultra-accommodative through CY11.
In Europe, Germany remains the main growth driver, benefitting from strong
economic momentum in EMs and ongoing recovery in the US. However, the
periphery remains trapped in lack of competitiveness, high level of indebtedness
and unemployment and ongoing fiscal retrenchment. We expect economic
performance to remain divergent in the region. The main risk to the region and to
the global economy arises from the lingering sovereign debt crisis in the region.
In emerging economies, policy stimulus, inventory re-stocking and sharp
turnaround in global trade since March 2009 led to strong recovery, such that
many EMs are now growing close to potential. Largely supportive financial markets
further aided the economic recovery. More recent trends suggest that investments
and private consumption trends are picking up in EMs even as policy stimulus fades.
Yet, policy environment in EMs is characterised by multiple challenges. The ultraloose
monetary policy adopted by Fed, ECB, BoE, and BoJ is resulting in upward
pressure on domestic inflation in EMs (through higher global commodity/crude oil
prices) and upward pressure on exchange rates and asset prices (due to rising
capital inflows). Therefore, EMs policymakers have to walk a tightrope in the
coming quarters.
�� India’s economic expansion brisk and balanced, but, concerns have risen
After bottoming out in March 2009, India’s economic expansion has been very
robust. Sequential seasonally adjusted data suggest that the economy has now
regained its pre-crisis growth trajectory. With the release of Q2FY11 GDP
numbers (real GDP growth at 8.9% Y-o-Y), it is established that growth is brisk
and balanced. All the three sectors - services, industry and agriculture - are
showing strong output growth. On the demand side as well, private consumption
and investments have picked up strongly.
The upswing in the industrial production growth has been the result of inventory restocking
(as demand recovered), very favourable base effect (as activity was very weak
last year), recovery in India’s exports (in line with recovery in global trade), benign
interest rate environment and recovery in business sentiments. Services too have shown
very strong momentum, growing at a solid 9.8% Y-o-Y in Q2FY11, over and above
10.5% Y-o-Y registered in the same quarter last year. Indeed, over the past three
quarters, the contribution of services to GDP growth has been rising, while that of the
industry has been declining. The current phase of recovery in services has been
characterised by falling contribution of the financial and business services segment
(finance, real estate, business and insurance) and rising contribution from trade, hotel
and transport services. Pick up in private consumption and recovery in global trade
supported this trend.
Going ahead, private consumption is likely to lead the economic momentum, with
investments gathering pace gradually through 2011. However, government support to
the economy will be gradually reducing, while trade deficit will continue to be a drag on
the economic growth. Overall, we expect real GDP to show some moderation in the
coming quarters, particularly in Q4FY11. For FY11, we project real GDP growth at 8.6%
Y-o-Y.
However, macro-headwinds have gathered pace for the Indian economy. The first is the
widening current account deficit and shifting nature of funding of the deficit towards non-
FDI flows. The latest data release for Q2FY11 shows that current account deficit has
widened to ~4% of GDP from 3.2% in the previous quarter, led by slower exports and
below trend growth in invisibles surplus. Rising crude oil prices suggest that even if exports
grow at healthy pace, current account deficit may remain elevated. At the same time, the
share of non-FDI inflows in the capital account has risen quite sharply from ~65% in
Q2FY10 to ~87% in Q2FY11. This is worrying because non-FDI flows tend to be volatile in
nature as they are highly influenced by the global risk appetite. Secondly, rising global
commodity and crude oil prices are adversely affecting the domestic inflation scenario.
Sequential trend in inflation suggests that price pressures have increased in recent months.
While rebound in food inflation in recent weeks (led by unseasonal rains in November and
associated speculative hoarding) may ease in the coming weeks, the core-inflation (nonfood
manufacturing inflation) is also showing sideways movement. Accordingly, the central
bank is expected to remain hawkish in the coming quarters. Lastly, recent instances of
lapses in corporate governance have negatively impacted India’s image as an investment
destination.
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