Please Share:: 
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Overview and Summary
Weak currency reflects global events, credit squeeze ahead
Rupee is sliding (c.7% viz dollar since start of the year) – how to regard it? Ostensibly, the weaker rupee reflects global
events: European policy paralysis, credit downgrades, drying up of global QE all of which combine to promote the US
dollar. The stronger dollar has forced us to change our INR forecasts to 47 and 44 by 2011 y/e and 2012 y/e respectively.
But there’s more. For a current account deficit economy currency weakness is a key part of the process by which credit is
squeezed further. The reason is that a drain in external funds almost always produces a credit squeeze and interest
rate spike despite the authority’s ability to cushion it. Faced with this prospect further monetary tightening seems
redundant, the question is how soon the easing?
Short term, pressures acting against the rupee remain in place. Economic growth is weak and should weaken further.
The cost of capital is high and cost inflation remains a problem for corporate profitability. Bank lending is slowing and so
is investment. Inflation is still high and this holds back appreciation. The whole thrust of policy has been anti-inflationary,
so high yields have matched inflation (p22-24). The economy is set up to be very vulnerable to any negative global
event (trade or capital). The currency is starting to reflect this.
Things to watch
Looking ahead there are two areas to watch. First, the chance of generic outflows of foreign capital. Watch official FX
reserves and short rates in response to global events. The current account deficit (p14) makes Indian financial markets
vulnerable to a drain in foreign funds, but the good news is any drain should be cushioned by a rundown in official FX
reserves. Official reserves are high relative to external debt: external debt of $305bn of which $65bn is short term.
Official FX reserves of $280bn cover 90% of the total). In other words local factors do not argue for a snowball-effect,
but the process of containing any drain would initially involve tighter credit conditions and an interest rate spike,
thereafter easier money policy should contain the after-effects.
Second, there is a knock-on impact of the weaker rupee on local inflation, if oil prices do not fall further. And that is the
key proviso. The chart below shows the lag between rupee-denominated oil inflation and WPI. There is some inflation
relief in the immediate quarter ahead - we think WPI can slow c.2%. But what’s worrying investors short term is: what if
oil prices don’t drop further and a weaker currency boosts local WPI inflation? A simple calculation suggests that rupee
oil inflation (currently averaging 42%) has further room to slow if the exchange rate holds at 48 – ie negligible impact.
An INR of 50 or beyond mechanically boosts rupee oil inflation - blue line in chart below. But ultimately, any global
event pushing INR beyond 50 could also push oil prices down more too so these are temporary concerns.
Gross Domestic Product
What the numbers say: Overall real GDP has been slowing for the last 4 quarters to 7.7% in Jun-11. Investment
bounced but remains generally weak (7.9% Jun), industry up 5.1%. Consumption is strong but slipping (6.3% Jun
from 8.1% Mar). Services has held up (10% in Jun, up from 8.7% Mar).
What they mean: The capex/industrial-driven recovery in GDP finds a slower speed while profits weather the high
commodity prices. There is a stronger consumption flavour to economic growth, but even consumption is restrained to
a degree by the high interest rates and upcoming credit slowdown.
12-month outlook: Weaker. In 2011-12 we expect real GDP growth to slow to 7.2% with H2 seeing the slowest
momentum (sub 7%). We expect global growth to slow this year. We think growth in real investment and
consumption can slow to 7.6% (from 8.6%) and 5.7% (from 8.6% respectively.
Consumption
What the numbers say: Private consumption in Jun-11 slowed to 6.3% but remains pretty robust. Consumer credit is
up 17%YoY and our UBS retail sale index (compiled from bottom up retail product vendors) still up at 13%YoY.
Freight indicators are mixed (rail freight strong: air weak). Auto sales growth weakening. Financial indicators of
transactions activity like real cash in circulation or M1 are slower (ie high interest rates a restraint).
What they mean: There is a strong demographic story and agri-incomes have been boosted by higher food prices. But
consumption is moderating as rates stay high and banks run up against lending constraints.
12-month outlook: Weaker. After a rapid run-up in consumption last year (8.6% real growth) we see slowdown to
7.6% in 2011-12 due to the higher oil price impact on company investment, wages and discretionary income. But this
is a short-term pause. The bigger question is: are global investors willing to fund Indian banks to sustain the great
Indian consumption story at previous growth rates? And how long will it take for the advent of multi-product retailing
to change the pace of these consumer trends? (our UBS retail index is product-based not store-based)
Government
What the numbers say: Monthly fiscal position stopped improving due to drop in tax revenue. For 2011-12 the
government expects deficit to be Rs 4.1tn (equivalent to 4.6% GDP, from Rs4tn, 5.1% GDP in 2010-11). From a
funding angle they need Rs3.4tn net domestic borrow. But there are risks. These numbers heavily rely on subsidy
cut (from 2.1% of GDP to 1.6%) and divestment proceeds of Rs400bn. The harder work of meaningfully improving
the tax/GDP through GST and freeing up diesel prices has been delayed again.
What they mean: Diesel prices were hiked in June. But another hike is probably required to meet budget numbers.
Otherwise, absent a dramatic drop in oil prices we suspect the budget could miss by 0.5% of GDP, ie another Rs400bn
required. Rating upgrade probably requires GST/fuel tariff reform.
12-month outlook: Neutral/negative. The main risks to budget arithmetic are: rising oil prices and disappointing
divestment proceeds. Currently excess government securities holdings of banks are at 3% of deposits (chart 6 p20).
The system can probably absorb another Rs400bn with negligible rise in this ratio. More difficult to ascertain is the
rise in state bond issues given State Electricity Board losses.
Investment
What the numbers say: Real investment growth bounced to 7.9% in Jun-11from 0.4% in Mar-11. Infrastructure
indicators have held up a bit better. Although from chart 1 it looks like a rerun of the 2008-09 capex drop what’s
different this time is the lesser drop in profitability and stronger funding availability – so far!
What they mean: Investment is mainly a private sector phenomenon and is suffering a lull due to slower company
earnings momentum and a reduced government contracting of projects. Uncertainty has been high during the anticorruption
drives, amid State elections.
12-month outlook: Step down ahead. We expect only 5.7% real investment growth 2011-12 and 32-35%
investment to GDP ratio. Bank lending is about to be squeezed by the global credit squeeze. Fiscal constraints mean
there is very limited ability for the government to offset the private sector capex slowdown with its own spending,
though it can push forward various infrastructure projects and boost order-books. Also key is to monitor profits,
foreign capital flows and changes to FDI rules such as those allowing foreign investors into multi-product retailing or
other sectors in the upcoming free trade agreement (FTA) with EU.
Industrial Production
What the numbers say: IP growth slumped to 3.3% in July, averaging 6% over the last 3 months. Capital goods
production particularly in ‘heavy’ industries (chart 1, 9, 10) has been a drag, but in some industries there is a bounce.
Intermediate goods output sinks to negative growth, consumer goods going soft (chart 2).
What they mean: The recent lull in infrastructure execution due to political events has dampened activity. Higher
cost inflation plus tighter credit conditions have all eaten into profitability. We suspect controlling costs is what
temporarily depresses industrial activity growth. Watch profits for signs of change. Our lead economic indicator (LEI)
for IP is still flat in March – chart 6.
12-month outlook: ‘V’ shape ahead. IP faces a further period of weakness, possibly a downspike depending on the
shape of the global slowdown and severity of upcoming drain in foreign capital. Even in a benign view the struggle to
contain costs in any global slowdown could keep conditions weak in H2. Our LEI says too early for IP recovery.
Balance of Payments
What the numbers say: Monthly trade deficit widened in Aug reflecting higher oil and non-oil imports. Imports up
39%YoY, exports up 44%, starting to come off their high base. Quarterly current a/c improved only a bit due to slow
remittances and jump in imports of financial/business services leapt. Inward foreign capital diminishing.
What they mean: The problem ahead is slower exports as global demand slows. This year should see some cyclical
deterioration in trade gap. Foreign capital remains adequate, but a drain appears increasingly likely in H2.
12-month outlook: Negative. Much depends on how much OECD really does slow and the severity of any foreign
capital withdrawl. Our basic call is for slower export growth 20% below imports at 22%. Then the trade gap widens to
$132bn in 2011-12 from $105bn. If services, transfers and income rise only modestly from $86bn to $96bn then the
current account can be flat at c. $45bn ($44bn in 2010-11). The risk is a more serious OECD slowdown, but that could
also reduce oil prices and subdue oil imports (currently we assume $105 bbl for OPEC basket of oils in 2011-12).
Trade Direction
What the numbers say: Exports have held up well and remain strong. Imports after a period of sluggishness have
leapt up.
What they mean: Data breakdown is not available, but the latest import spike could be a mix of oil and non-oil
(possibly pent up import demand for infrastructure materials after the anti-corruption-related pause). Demand for
Indian exports from EM and developed has been strong in 2010-11. This year, 2011-12 may be more challenging as
global growth slows.
12-month outlook: Soft. Probably uneven trajectory ahead. Despite a slowdown in global demand, we expect export
growth to average 20% (down from 38%). Meanwhile, we expect imports to display more erratic growth of around
22% - a slower domestic economy is a restraint on imports.
Trade by Category
What the numbers say: Imports of capital goods have remained fairly subdued in this recovery – reflecting low FDI
and the short capex burst. Exports of manufactured goods (mainly engineering/chemicals) have done
disproportionately well in the recent OECD recovery. (Engineering exports: trspt equipment, rubber manuf'td prdts,
residual engineering items, project goods, semi-finished iron & steel, metal manufactures, machine tools, machinery
& instruments, iron, steel bars, rods. Chems & related: caster oil, cosmetics, drugs/pharma, dyes, inorganic/organic
agri, manmade fabric, paints etc, platic& linoleum, residual chems)
What they mean: The latest import spike looks like it could be a mix of oil and non-oil (possibly pent up import
demand for infrastructure materials after the anti-corruption-related pause). Demand for Indian exports has been
strong in 2010-11. This year, 2011-12 could see a cyclical slowdown.
12-month outlook: Soft. Expect some reversal of the trade balance improvement, but limited by still slow capex
cycle in India and longer term rise in ratio of manufactured exports to capital goods imports. Main speed limiters are:
the tightening in China, EU funding crisis and moderation to G3 demand 6-12m ahead. Exports could still manage
20%. A very positive sign is the emergent stronger manufactured goods balance
Exchange Rate
What the numbers say: FX reserves have slipped with the recent bout of dollar strength. This can continue. In tradeweighted
terms, the rupee tracks the Rs/$ rate. (chart 4). Meanwhile local inflation has pushed up the real exchange
rate much more (chart 1).
What they mean: Local financial markets would be hit by any FX drain. Dollar strength can persist or extend given:
(1) policy paralysis in West, (2) no new QE due to inflation and (3) slower global growth. India policymakers have
little scope to cut rates or boost spending this time round so a slower stage of Indian growth can trigger INR weaker.
12-month outlook: Weakness then appreciation. Near-term there is a serious risk of a downspike in INR past 50
(weaker INR), but over the year we expect a lesser depreciation. We change our forecasts to a depreciation to 47 by
end-2011, then appreciation to 44 in 2012.
Money and Credit
What the numbers say: M3 & adjusted money base growth are steady at c.17%. Bank lending has run up against
balance sheet constraints (high L/D ratio) and so credit growth has peaked and in a slowdown (chart 11). Impact of
FX drain not apparent.
What they mean: Credit growth is very vulnerable to sharp slowdown beyond deposits. This contrasts with
today’s picture of credit growth still 3-4% higher than deposit growth (charts 10-11) prompting banks to offer more
debt notes and rebuild their capital bases. FX reserves have dropped a bit and could be run down on any external drain
in funds. In these conditions RBI remains the marginal supplier of domestic funds to the system to support bank
lending.
12-month outlook: Near-term risk of squeeze. Near-term the balance of payments is a negative drain on interbank
funds and there is a risk of a serious squeeze if global conditions deteriorate or there is a freezing-up in global credit
conditions. In these conditions the RBI should be expected to inject (as now) to avoid a more serious spike in local
rates and drop in credit growth. 10-15% for bank lending is looking increasingly likely.
Interest Rates
What the numbers say: So far RBI has hiked CRR by 100bp to 6% and the LAF interest rate corridor by 350bps. The
key policy rate: Repo is at 8.25%. After the tax-payment squeeze in March, market yields have dropped. CP and
interbank rates have declined c. 100bp to around 9%. But that is the full extent of the easing in credit conditions. OIS
rates are feeling for a decline, but for now are stopped out by yesterday’s inflation.
What they mean: Credit demand has slowed - reflected in lower market yields. Policy rates have been hiked
alongside the rise in global commodity prices. But until either inflation capitulates or credit suffers an external-driven
blow market yields & OIS appear stuck at current levels.
12-month outlook: Tightening over, easing ahead. Given the factors driving dollar strength are likely to remain in
place, short-term we think the system is vulnerable to an external drain. Policy response should be to inject funds to
alleviate the scramble created by a rundown in FX reserves, with possible rate cuts to cushion the squeeze in credit.
Inflation
What the numbers say: CPI indices have slowed and converged on 8%. Food, services and finished consumer goods
inflation - all categories are slowing. But WPI still holds up (9.8% Jul) because of hikes in fuel and electricity.
Importantly global commodity prices/inflation (as defined by CRB) have peaked for now.
What they mean: We believe inflation facing consumer (CPI) is around 8% and absent a recession, industrial
inflation (WPI) basically fluctuates in a 7-10% range. Currently, we are near top of that range as lagged impact of
suppressed inflation pops through. Although WPI and CPI still point in opposite directions, the key to WPI is global
commodity inflation, and this looks to have peaked. We think Oct is the earliest WPI can start to slow.
12-month outlook: Down. By Mar-12 we expect CPI at 7%, WPI at 7.7% (after rising to 10% in interim). We
assume UBS’ $104 bbl average for global crude. Slow inflation arguments: (i) slower food inflation (chart 3), (ii)
restraining credit policy plus lower economic growth, (iii) slower CRB and rising chance of globally induced credit
squeeze.
Asset Prices
What the numbers say: Profitability and sales are in modest slowdown. Costs have been boosted by higher global
commodity prices and wage inflation. Monetary policy has tightened in line with commodity prices so aggregate
demand is also sinking. There needs to be more active cost-control by corporate India and this restrains growth.
What they mean: More difficult conditions for corporate profitability partly explain slower investment growth. The
main risk in the immediate month ahead is of a more intense credit slowdown with an up-spike in market interest rates.
12-month outlook: ‘V’ shape. On a benign economic view (ie no G3 recession) then the main question remains will
corporate profits & sales growth (in general) be able to retain the average rates of growth last seen pre-global slump?
i.e. 2004-7 – a period of time when oil prices rose at 20-30% pa throughout. But if there is a re-run of 2008 credit
conditions then the additional issue is one of timing.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Overview and Summary
Weak currency reflects global events, credit squeeze ahead
Rupee is sliding (c.7% viz dollar since start of the year) – how to regard it? Ostensibly, the weaker rupee reflects global
events: European policy paralysis, credit downgrades, drying up of global QE all of which combine to promote the US
dollar. The stronger dollar has forced us to change our INR forecasts to 47 and 44 by 2011 y/e and 2012 y/e respectively.
But there’s more. For a current account deficit economy currency weakness is a key part of the process by which credit is
squeezed further. The reason is that a drain in external funds almost always produces a credit squeeze and interest
rate spike despite the authority’s ability to cushion it. Faced with this prospect further monetary tightening seems
redundant, the question is how soon the easing?
Short term, pressures acting against the rupee remain in place. Economic growth is weak and should weaken further.
The cost of capital is high and cost inflation remains a problem for corporate profitability. Bank lending is slowing and so
is investment. Inflation is still high and this holds back appreciation. The whole thrust of policy has been anti-inflationary,
so high yields have matched inflation (p22-24). The economy is set up to be very vulnerable to any negative global
event (trade or capital). The currency is starting to reflect this.
Things to watch
Looking ahead there are two areas to watch. First, the chance of generic outflows of foreign capital. Watch official FX
reserves and short rates in response to global events. The current account deficit (p14) makes Indian financial markets
vulnerable to a drain in foreign funds, but the good news is any drain should be cushioned by a rundown in official FX
reserves. Official reserves are high relative to external debt: external debt of $305bn of which $65bn is short term.
Official FX reserves of $280bn cover 90% of the total). In other words local factors do not argue for a snowball-effect,
but the process of containing any drain would initially involve tighter credit conditions and an interest rate spike,
thereafter easier money policy should contain the after-effects.
Second, there is a knock-on impact of the weaker rupee on local inflation, if oil prices do not fall further. And that is the
key proviso. The chart below shows the lag between rupee-denominated oil inflation and WPI. There is some inflation
relief in the immediate quarter ahead - we think WPI can slow c.2%. But what’s worrying investors short term is: what if
oil prices don’t drop further and a weaker currency boosts local WPI inflation? A simple calculation suggests that rupee
oil inflation (currently averaging 42%) has further room to slow if the exchange rate holds at 48 – ie negligible impact.
An INR of 50 or beyond mechanically boosts rupee oil inflation - blue line in chart below. But ultimately, any global
event pushing INR beyond 50 could also push oil prices down more too so these are temporary concerns.
Gross Domestic Product
What the numbers say: Overall real GDP has been slowing for the last 4 quarters to 7.7% in Jun-11. Investment
bounced but remains generally weak (7.9% Jun), industry up 5.1%. Consumption is strong but slipping (6.3% Jun
from 8.1% Mar). Services has held up (10% in Jun, up from 8.7% Mar).
What they mean: The capex/industrial-driven recovery in GDP finds a slower speed while profits weather the high
commodity prices. There is a stronger consumption flavour to economic growth, but even consumption is restrained to
a degree by the high interest rates and upcoming credit slowdown.
12-month outlook: Weaker. In 2011-12 we expect real GDP growth to slow to 7.2% with H2 seeing the slowest
momentum (sub 7%). We expect global growth to slow this year. We think growth in real investment and
consumption can slow to 7.6% (from 8.6%) and 5.7% (from 8.6% respectively.
Consumption
What the numbers say: Private consumption in Jun-11 slowed to 6.3% but remains pretty robust. Consumer credit is
up 17%YoY and our UBS retail sale index (compiled from bottom up retail product vendors) still up at 13%YoY.
Freight indicators are mixed (rail freight strong: air weak). Auto sales growth weakening. Financial indicators of
transactions activity like real cash in circulation or M1 are slower (ie high interest rates a restraint).
What they mean: There is a strong demographic story and agri-incomes have been boosted by higher food prices. But
consumption is moderating as rates stay high and banks run up against lending constraints.
12-month outlook: Weaker. After a rapid run-up in consumption last year (8.6% real growth) we see slowdown to
7.6% in 2011-12 due to the higher oil price impact on company investment, wages and discretionary income. But this
is a short-term pause. The bigger question is: are global investors willing to fund Indian banks to sustain the great
Indian consumption story at previous growth rates? And how long will it take for the advent of multi-product retailing
to change the pace of these consumer trends? (our UBS retail index is product-based not store-based)
Government
What the numbers say: Monthly fiscal position stopped improving due to drop in tax revenue. For 2011-12 the
government expects deficit to be Rs 4.1tn (equivalent to 4.6% GDP, from Rs4tn, 5.1% GDP in 2010-11). From a
funding angle they need Rs3.4tn net domestic borrow. But there are risks. These numbers heavily rely on subsidy
cut (from 2.1% of GDP to 1.6%) and divestment proceeds of Rs400bn. The harder work of meaningfully improving
the tax/GDP through GST and freeing up diesel prices has been delayed again.
What they mean: Diesel prices were hiked in June. But another hike is probably required to meet budget numbers.
Otherwise, absent a dramatic drop in oil prices we suspect the budget could miss by 0.5% of GDP, ie another Rs400bn
required. Rating upgrade probably requires GST/fuel tariff reform.
12-month outlook: Neutral/negative. The main risks to budget arithmetic are: rising oil prices and disappointing
divestment proceeds. Currently excess government securities holdings of banks are at 3% of deposits (chart 6 p20).
The system can probably absorb another Rs400bn with negligible rise in this ratio. More difficult to ascertain is the
rise in state bond issues given State Electricity Board losses.
Investment
What the numbers say: Real investment growth bounced to 7.9% in Jun-11from 0.4% in Mar-11. Infrastructure
indicators have held up a bit better. Although from chart 1 it looks like a rerun of the 2008-09 capex drop what’s
different this time is the lesser drop in profitability and stronger funding availability – so far!
What they mean: Investment is mainly a private sector phenomenon and is suffering a lull due to slower company
earnings momentum and a reduced government contracting of projects. Uncertainty has been high during the anticorruption
drives, amid State elections.
12-month outlook: Step down ahead. We expect only 5.7% real investment growth 2011-12 and 32-35%
investment to GDP ratio. Bank lending is about to be squeezed by the global credit squeeze. Fiscal constraints mean
there is very limited ability for the government to offset the private sector capex slowdown with its own spending,
though it can push forward various infrastructure projects and boost order-books. Also key is to monitor profits,
foreign capital flows and changes to FDI rules such as those allowing foreign investors into multi-product retailing or
other sectors in the upcoming free trade agreement (FTA) with EU.
Industrial Production
What the numbers say: IP growth slumped to 3.3% in July, averaging 6% over the last 3 months. Capital goods
production particularly in ‘heavy’ industries (chart 1, 9, 10) has been a drag, but in some industries there is a bounce.
Intermediate goods output sinks to negative growth, consumer goods going soft (chart 2).
What they mean: The recent lull in infrastructure execution due to political events has dampened activity. Higher
cost inflation plus tighter credit conditions have all eaten into profitability. We suspect controlling costs is what
temporarily depresses industrial activity growth. Watch profits for signs of change. Our lead economic indicator (LEI)
for IP is still flat in March – chart 6.
12-month outlook: ‘V’ shape ahead. IP faces a further period of weakness, possibly a downspike depending on the
shape of the global slowdown and severity of upcoming drain in foreign capital. Even in a benign view the struggle to
contain costs in any global slowdown could keep conditions weak in H2. Our LEI says too early for IP recovery.
Balance of Payments
What the numbers say: Monthly trade deficit widened in Aug reflecting higher oil and non-oil imports. Imports up
39%YoY, exports up 44%, starting to come off their high base. Quarterly current a/c improved only a bit due to slow
remittances and jump in imports of financial/business services leapt. Inward foreign capital diminishing.
What they mean: The problem ahead is slower exports as global demand slows. This year should see some cyclical
deterioration in trade gap. Foreign capital remains adequate, but a drain appears increasingly likely in H2.
12-month outlook: Negative. Much depends on how much OECD really does slow and the severity of any foreign
capital withdrawl. Our basic call is for slower export growth 20% below imports at 22%. Then the trade gap widens to
$132bn in 2011-12 from $105bn. If services, transfers and income rise only modestly from $86bn to $96bn then the
current account can be flat at c. $45bn ($44bn in 2010-11). The risk is a more serious OECD slowdown, but that could
also reduce oil prices and subdue oil imports (currently we assume $105 bbl for OPEC basket of oils in 2011-12).
Trade Direction
What the numbers say: Exports have held up well and remain strong. Imports after a period of sluggishness have
leapt up.
What they mean: Data breakdown is not available, but the latest import spike could be a mix of oil and non-oil
(possibly pent up import demand for infrastructure materials after the anti-corruption-related pause). Demand for
Indian exports from EM and developed has been strong in 2010-11. This year, 2011-12 may be more challenging as
global growth slows.
12-month outlook: Soft. Probably uneven trajectory ahead. Despite a slowdown in global demand, we expect export
growth to average 20% (down from 38%). Meanwhile, we expect imports to display more erratic growth of around
22% - a slower domestic economy is a restraint on imports.
Trade by Category
What the numbers say: Imports of capital goods have remained fairly subdued in this recovery – reflecting low FDI
and the short capex burst. Exports of manufactured goods (mainly engineering/chemicals) have done
disproportionately well in the recent OECD recovery. (Engineering exports: trspt equipment, rubber manuf'td prdts,
residual engineering items, project goods, semi-finished iron & steel, metal manufactures, machine tools, machinery
& instruments, iron, steel bars, rods. Chems & related: caster oil, cosmetics, drugs/pharma, dyes, inorganic/organic
agri, manmade fabric, paints etc, platic& linoleum, residual chems)
What they mean: The latest import spike looks like it could be a mix of oil and non-oil (possibly pent up import
demand for infrastructure materials after the anti-corruption-related pause). Demand for Indian exports has been
strong in 2010-11. This year, 2011-12 could see a cyclical slowdown.
12-month outlook: Soft. Expect some reversal of the trade balance improvement, but limited by still slow capex
cycle in India and longer term rise in ratio of manufactured exports to capital goods imports. Main speed limiters are:
the tightening in China, EU funding crisis and moderation to G3 demand 6-12m ahead. Exports could still manage
20%. A very positive sign is the emergent stronger manufactured goods balance
Exchange Rate
What the numbers say: FX reserves have slipped with the recent bout of dollar strength. This can continue. In tradeweighted
terms, the rupee tracks the Rs/$ rate. (chart 4). Meanwhile local inflation has pushed up the real exchange
rate much more (chart 1).
What they mean: Local financial markets would be hit by any FX drain. Dollar strength can persist or extend given:
(1) policy paralysis in West, (2) no new QE due to inflation and (3) slower global growth. India policymakers have
little scope to cut rates or boost spending this time round so a slower stage of Indian growth can trigger INR weaker.
12-month outlook: Weakness then appreciation. Near-term there is a serious risk of a downspike in INR past 50
(weaker INR), but over the year we expect a lesser depreciation. We change our forecasts to a depreciation to 47 by
end-2011, then appreciation to 44 in 2012.
Money and Credit
What the numbers say: M3 & adjusted money base growth are steady at c.17%. Bank lending has run up against
balance sheet constraints (high L/D ratio) and so credit growth has peaked and in a slowdown (chart 11). Impact of
FX drain not apparent.
What they mean: Credit growth is very vulnerable to sharp slowdown beyond deposits. This contrasts with
today’s picture of credit growth still 3-4% higher than deposit growth (charts 10-11) prompting banks to offer more
debt notes and rebuild their capital bases. FX reserves have dropped a bit and could be run down on any external drain
in funds. In these conditions RBI remains the marginal supplier of domestic funds to the system to support bank
lending.
12-month outlook: Near-term risk of squeeze. Near-term the balance of payments is a negative drain on interbank
funds and there is a risk of a serious squeeze if global conditions deteriorate or there is a freezing-up in global credit
conditions. In these conditions the RBI should be expected to inject (as now) to avoid a more serious spike in local
rates and drop in credit growth. 10-15% for bank lending is looking increasingly likely.
Interest Rates
What the numbers say: So far RBI has hiked CRR by 100bp to 6% and the LAF interest rate corridor by 350bps. The
key policy rate: Repo is at 8.25%. After the tax-payment squeeze in March, market yields have dropped. CP and
interbank rates have declined c. 100bp to around 9%. But that is the full extent of the easing in credit conditions. OIS
rates are feeling for a decline, but for now are stopped out by yesterday’s inflation.
What they mean: Credit demand has slowed - reflected in lower market yields. Policy rates have been hiked
alongside the rise in global commodity prices. But until either inflation capitulates or credit suffers an external-driven
blow market yields & OIS appear stuck at current levels.
12-month outlook: Tightening over, easing ahead. Given the factors driving dollar strength are likely to remain in
place, short-term we think the system is vulnerable to an external drain. Policy response should be to inject funds to
alleviate the scramble created by a rundown in FX reserves, with possible rate cuts to cushion the squeeze in credit.
Inflation
What the numbers say: CPI indices have slowed and converged on 8%. Food, services and finished consumer goods
inflation - all categories are slowing. But WPI still holds up (9.8% Jul) because of hikes in fuel and electricity.
Importantly global commodity prices/inflation (as defined by CRB) have peaked for now.
What they mean: We believe inflation facing consumer (CPI) is around 8% and absent a recession, industrial
inflation (WPI) basically fluctuates in a 7-10% range. Currently, we are near top of that range as lagged impact of
suppressed inflation pops through. Although WPI and CPI still point in opposite directions, the key to WPI is global
commodity inflation, and this looks to have peaked. We think Oct is the earliest WPI can start to slow.
12-month outlook: Down. By Mar-12 we expect CPI at 7%, WPI at 7.7% (after rising to 10% in interim). We
assume UBS’ $104 bbl average for global crude. Slow inflation arguments: (i) slower food inflation (chart 3), (ii)
restraining credit policy plus lower economic growth, (iii) slower CRB and rising chance of globally induced credit
squeeze.
Asset Prices
What the numbers say: Profitability and sales are in modest slowdown. Costs have been boosted by higher global
commodity prices and wage inflation. Monetary policy has tightened in line with commodity prices so aggregate
demand is also sinking. There needs to be more active cost-control by corporate India and this restrains growth.
What they mean: More difficult conditions for corporate profitability partly explain slower investment growth. The
main risk in the immediate month ahead is of a more intense credit slowdown with an up-spike in market interest rates.
12-month outlook: ‘V’ shape. On a benign economic view (ie no G3 recession) then the main question remains will
corporate profits & sales growth (in general) be able to retain the average rates of growth last seen pre-global slump?
i.e. 2004-7 – a period of time when oil prices rose at 20-30% pa throughout. But if there is a re-run of 2008 credit
conditions then the additional issue is one of timing.
No comments:
Post a Comment