Mother India and Uncle Sam: Terms of hurt :: BofA ML

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Mother India and Uncle Sam:
Terms of hurt
Bottom line: US slowdown to hurt, though relatively less  
„ We publish our responses to client queries about the impact of the US slow
down on the Indian economy. First, will growth be hit? Yes, we cut our FY12
growth forecast further by 20bp to 7.6% after our US economist, Ethan Harris,
slashed his 2012 growth by 60bp to 2.3%. Second, can inflation peak off if the
Fed introduces QE-III? We still stick to our call of inflation peaking off at 10%
levels in September (and do note QE-III’s not our base case). After all,
commodity prices should logically have to struggle to climb higher if global
growth slows. Finally, will the RBI still tighten? Yes, we expect a 25bp policy
rate hike on September 16 unless the world crashes. If the present bout of risk
aversion resolves itself, the RBI will likely drag the hiking cycle into October.
Why it matters: Because the US matters, period  
„ We do not believe that India cannot be immune to an US slowdown. Sure,
domestic demand is a buffer: our Asia economist, T J Bond, estimates that
India is least leveraged to US growth in Asia (Chart 1). Still, if the US double
dips, growth should slow to 6.5%, given that high interest rates are already
hurting.  
Key points: Slower growth, rate peak off some distance      
„ 7.6% FY12 growth if US doesn’t double dip: We have cut growth further by
20bp to 7.6% in FY12 after our US economists slashed their growth forecasts
(Table 1). In particular, we have cut industrial growth by 80bp to 6.6%.
„ If the US doesn’t double dip, growth should bottom out in mid-2012. After all,
the RBI will likely cut rates by mid-2012. Besides, the winter rabi harvest
should do well with the Indus, which waters its wheat fields, filled to the brim.
„ If the US double dips (and our US economists assess a 30% chance), growth
should skid to 6.5% levels. Do read our stress-testing slowdown report here.
„ Inflation peak off in September: We still stick to our base case of inflation
peaking at 10% levels in September. Even if there is QE-III to counter US
slowing (which is not our base case), we expect global commodity prices to
struggle to climb higher in a slowing world.
„ 25bp RBI hike on September 16: We continue to expect the RBI to hike
policy rates by 25bp on September unless the world crashes. If the present
round of risk aversion resolves itself, it could well drag the rate hiking cycle to
its October 26 policy. After all, it is not until October inflation is announced on
November 14 that there will be full visibility of the peak off in inflation that we
expect. For details, do read our rates-peak-off report here.
„ With rates hurting growth, we believe the RBI should reverse its tight monetary
policy stance as soon as inflation turns down. We expect our first RBI rate cut
in July with inflation likely to fall below 7% levels by March 2012. In all, we
expect the RBI to cut rates by 75bp in 2012. If the RBI hikes more than
expected now, it will have to cut more (and faster) in 2012.
„ Against this backdrop, we continue to expect lending rates to go up 50bp by
December and come off 50bp in the April-September slack season as loan
growth slows to 17% levels. The 10y should persist in an 8-8.5% trading range
with RBI OMO funding the 1.2% of GDP fiscal deficit overrun we expect.