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What if India’s GDP growth trend slows to 7%?
While we note a trend GDP growth rate of 8-9% has been embedded in investor
expectations of India’s earnings growth/ROE trajectory, policy uncertainties, the
conflicting demands and compulsions of a popular democracy on the government
and India Inc’s growing discouragement, are increasing the risk of India’s -
medium term - GDP trajectory slowing towards 7%. In this note we have
attempted a sensitivity analysis to assess the impact of slowing growth on BSE
Sensex earnings and answer questions associated with a slowing GDP growth
trend. However, a 7% GDP growth trajectory is not our base case scenario with
our economists forecasting a 8% average GDP growth over next two years.
What will be the impact of a slowing growth on India’s valuation multiples?
We confess that India is beginning to lose some of its investor goodwill
accumulated over the past five to seven years. The perception of a slowing GDP
growth trend, could result in a further de-rating of the country’s valuation multiple
and a compression in its average premium to MSCI Asia nudging investors into an
even more cautious posture. Over the past few months we have seen a 260bps
compression in India’s PE valuation, driven by rising risk aversion (due to global
factors) and worries over policy uncertainties. While it is difficult to quantify the
extent of future valuation compression, we would think that valuations could get
reset to a level of 11x to 12x, which prevailed in the late nineties and first half of
previous decade (corresponding fair value range of 14500-16000 for the Sensex).
Moderate 3% downside risk to Sensex FY13 earnings
Our India research team’s extensive bottom up sensitivity analysis suggests a
downside of 3.2% to our current BSE Sensex earnings expectation for FY13,
taking earnings growth for FY13 to 12.5% from our current estimates of 16.3%.
While the downside risk to FY13 earnings sensitivity may appear muted, this could
be attributed to our analysts having already cut FY13 earnings estimates by 12%
since Apr’11 (relative to a 9% cut for FY12).
Highest downside risk to Capital Goods, Autos, Telecom
Capital Goods/Construction companies could witness the sharpest downside
risk (-11%) driven by 13% drop in L&T’s earnings and 11% drop in BHEL’s
earnings. Autos earnings could be impacted by ~7% led by Maruti (12%), M&M
(8%) and TAMO (6%). Telecom earnings could decline by 6%. For Banks, slowing
GDP growth would lead to asset quality concerns, with our Banking analyst
getting more worried on asset quality in the power and SMEs segments.
However, banks could likely restructure their power assets rather than classifying
them as NPLs which may lead to valuation multiple contraction.
What could allay downside concerns?
Bold policy actions on state electricity board reforms (power tariff hikes),
addressing supply side bottlenecks in coal, preventing any runaway increase in
fiscal deficit (through raising fuel and fertilizer prices) and most importantly
assuaging India Inc’s high pessimism, remain critical, in our opinion, to ensuring
that India’s investor goodwill is not impaired. Expectations of slowing global
growth and increasing regulatory focus on commodities may well be a silver lining
for government finances, if commodity (particularly oil) prices continue to ease.
What if GDP growth trend
slows to 7%?
With India’s real GDP growth averaging 8.4% over past five years, a trend growth rate of 8-
9% has now been embedded in investor expectations. We think this is not a wrong
assumption with India’s savings rate averaging 34%, forming the bedrock of the 8% growth
trajectory.
India has generated considerable attention as an investment destination driven by its unique
domestic consumption model, attractive demography and low correlation with global GDP
growth. Barring the global economic crisis years (2008-2009), India’s GDP growth has
averaged 9% over past 5 years. The 8-9% GDP growth trajectory has been broadly
embedded in India’s earnings growth/ROE trajectory expectations and as a corollary its
valuation bands. This trend has now embedded expectations of a structural BSE Sensex
earnings growth expectation of 20 to 25%, which has manifested in the country commanding
an average valuation premium of 300bps over the benchmark MSCI Asia.
While we are not forecasting a slowdown in India’s long term GDP growth trajectory, we
believe that policy uncertainties, the conflicting demands of a popular democracy on the
government (particularly during busy state election years) and India Inc’s rising despondency,
are increasing the risk of India’s - medium term - GDP trajectory slowing towards the 7%
level from the average 9% over past five years (ex- crisis period). These concerns can be
alleviated and the risk reduced considerably if (1) global commodity prices come off (2) clarity
emerges on coal supply bottlenecks and revision in power tariffs by state electricity boards
(3) return of India Inc’s business confidence and inclination to invest. Currently, consumption
from the Indian hinterland is doing the heavy lifting for the Indian economy. The
Government’s politically strategic inclusive growth initiatives are driving prosperity in the
Indian hinterland.
While investors are still hopeful over India’s attractive long term fundamentals, we are now
increasingly being asked about the impact of a slowing GDP trajectory on earnings growth,
sector positioning and valuation multiples.
We confess that it appears India is beginning to lose some of its investor goodwill
accumulated over the past five to seven years from its conscious attempt to improve its
public as well as private balance sheets, the government’s successful, preemptive efforts in
stimulating the domestic economy during the global economic crisis and its vibrant
investment story (domestic fixed capital formation grew at a CAGR of 16% over FY04-08).
In this note we have attempted to answer most of the questions we are being asked by
investors in the context of a slowing GDP growth trend. We reiterate that a 7% GDP growth
trajectory is not our base case scenario with our economists forecasting a 8% average GDP
growth over next two years. Bold policy actions on addressing supply side bottlenecks in
coal, preventing any runaway increase in fiscal deficit (raising fears of a crowding out of
private sector) and most importantly reducing India Inc’s high despondency remain critical to
ensuring that India’s investor good will is not impaired.
What will be the impact of slowing growth on BSE Sensex
earnings
Limited risk to FY13 Sensex earnings..:
Our India research team’s extensive bottom up analysis suggests a downside of 320bps to
our current BSE Sensex earnings expectation for FY13, taking earnings growth for FY13 to
12.5% from our current estimates. BSE Sensex aggregate EPS in FY13 would amount to
1323- relative to our current expectation of 1367.
… as analysts have already cut FY13 earnings estimates sharply : While the risk to FY13
earnings may appear muted, this could be attributed to our analysts cutting FY13 earnings
estimates aggressively. Our analysts have cut earnings expectations for FY13 by 12% since
Apr’11 (relative to a 9% cut for FY12). In addition with ~40% of Sensex earnings driven by
global factors (IT, Oil&Gas, Pharma, JLR, Corus etc.), the impact of a domestic slowdown is
tempered.
We see highest risk to earnings in Capital Goods, Property,
Autos, Telecom and Banks
Bottom up analysis of our analysts’ estimates suggest that in case of India’s GDP growth
slowing down to 7% purely on domestic factors, Capital Goods, Autos, Telecom and Banks
exhibit the highest downside in earnings from current levels:
Earnings of Capital Goods/Construction companies could witness the sharpest
downside risk (-11%) driven by 13% drop in L&T’s earnings and 11% drop in BHEL’s
earnings. Our sector analysts have factored in a 5%/10% decline in revenues of
BHEL/L&T, mainly as could slow down, particularly driven by deceleration in slow
moving orders. However, the impact of slowing order book growth could be partially
moderated by lower global commodity prices.
Autos earnings could be impacted by ~7%(in case GDP growth slows down to 7%),
with Maruti likely to see sharpest decline in FY13 earnings of 12%, as it could get dually
impacted by (i) significantly lower volume growth of just 9% (vs. our base case of 14%)
and (ii) a 60bps hit on EBITDA margins due to expectations of weaker INR vs. JPY.
Mahindra & Mahindra could be impacted by 8% as its UV and small CV segment could
likely see a sharp cut in volume growth, even as tractor growth should not be materially
impacted. For Tata Motors, domestic operations could take the biggest hit in the auto
pack (with MHCVs expected to de-grow by 8% and LCVs growth falling sharply by 10%
points), but the overall impact on earnings is moderated to just -6% due to no change to
its international operations (i.e. JLR, accounting for 65% of TAMO’s consol EBITDA).
Telecom’s (represented by Bharti only) earnings could face a downside risk of 6%, as
there could be a decline of 200bps in minutes growth and a shrinkage in tariff hike from
3.5% to 2.5%. Additionally, Bharti’s finances will also be hit by higher interest costs, on
account of depreciating INR.
For Financials, there could be a downside risk of 6% to our base case estimates, with
ICICI Bank most at risk (-10%), and HDFC Bank being least affected (-3%). Our banking
analyst Manish Karwa notes:
In case of slower economic growth, we believe that following could happen – (a) loan
growth could decelerate by ~200-300 bps (vs. base case of 18%), (b) on margins, we
believe that the industry is playing very rationally and despite a slower growth, we do
expect the system to make reasonably strong margins, (c) Asset quality will however be
the biggest concern and we are now getting slightly more worried on this especially in
the power and SMEs segments. While power sector continues to be plagued by
problems of its own, it is actually the SME/mid market segment which may see higher
delinquencies. SMEs roughly account for about 25% of the loan book, wherein, likely
NPLs could be 10-15% higher than general expectations. However, the impact of
slowdown may be staggered. Further, we believe that banks will most likely go for
restructuring their power assets rather than classifying it as NPLs. Thus, while reported
NPLs may not rise much, restructured asset are likely to be higher which may lead to
multiple contraction (d) Despite a slowdown, we are not much concerned on retail loans
and loans to large corporates which roughly constitute about 50-55% of total loans in
context of asset quality, but reiterate that growth may be slower in these segments.
IT Services, Oil & Gas, Utilities, Pharma and FMCG likely to be
least impacted
We do not see any meaningful impact on IT Services or Oil & Gas companies, as our
analysis envisages endogenous growth slowdown only. However, among other sectors
we see Utilities, FMCG and Pharma to be impacted only modestly:
For Utilities we expect no impact on earnings as India continues to remain in power
deficit mode with demand far outstripping the supply (despite robust growth of 9-10% in
electricity production over last 3 quarters). The current power deficit stands at ~10%.
Therefore, unless demand growth moves down to zero (a highly unlikely event, even if
GDP growth slows down to 7%), India will continue to remain power deficient, and
hence there should not be any impact on power utility companies in Sensex. Our Utilities
analyst Abhishek Puri notes further that:
We estimate that under demand slowdown, power spot rates could well settle at INR
3.5/unit. The most impacted players from demand slowdown would be marginal
contributors to the sector, or merchant power projects, as the spot tariffs could be
impacted negatively on reducing power deficit- highest exposure in FY13E will be for
JSPL (1.8GW), JSW Energy (1.6GW) and Adani/Lanco Infra (1.2GW) – but the impact on
JSPL could be moderates given that it is the lowest cost producers.
For Coal India, we do not foresee a decline in volume growth, and impact, if any, could
probably be through lower e-auction prices, bringing down Coal India’s earnings by 1%
only.
For FMCG too, the likely impact on earnings is limited to -2%, as ITC’s cigarette sales
remains relatively inelastic to economic cycles, while for HUVR, the margin pressures
could be partially offset by lower raw material costs.
Pharmaceuticals earnings could also remain insulated from domestic headwinds (with
~55% of Sensex pharma companies’ revenue coming from export). On domestic
revenue too, demand is largely secular in nature and independent of economic
conditions and hence we only see a likely 2% downside risk in earnings.
Impact on consumption, investments and BoP
Our calculation suggests that for a 7% real GDP growth, private consumption growth would
have to moderate to 5% (from a likely 7% growth in FY11/12) and investment growth should
ease to 7% (from an already low growth expectation of 8.0% in FY11/12). Exports and
imports growth should also moderate by 7-8%, with a likely bigger slowdown in imports
component, to reflect weak momentum in the domestic economy. As a result, trade deficit
should narrow by 50bps to 7.0% of GDP, helping the current account deficit to also shrink
somewhat and thereby supporting a modest appreciation of the rupee from current levels.
However, in a low growth scenario, there would be lesser scope for the rupee to appreciate
sharply, as foreign capital inflows (both FDI and portfolio investment) would be expected to
remain muted, compared to its historical trend.
Impact on inflation and the likely response of RBI
Intuitively, a low growth scenario also implies a reasonably lower inflation outturn through the
course of FY12/13. However we are not factoring any sharp deceleration in WPI inflation,
even under a 7% growth assumption. Given that part of India’s inflation has become
structural in nature (owing to supply bottlenecks in both infrastructure and agricultural sector)
and given our assumption that global crude oil prices would not fall sharply below the
USD100/barrel mark, WPI inflation in such a scenario would only moderate close to the RBI’s
comfort range of 5-5.5%, but unlikely to dip substantially below this level. Bank credit growth
would slow down to around 15%, reflecting weak economic activity, but unlikely to fall to a
single digit level owing to continued borrowing demand from oil marketing companies (with
government subsidy payments compensating loss making OMC’S with substantial lags). In
such a low growth-stable inflation scenario, RBI would have the window to entertain rate cuts
of 100-125ps, to bring the real policy rate close to the neutral level, in our view.
Impact on fiscal deficit
However, the biggest negative impact would be on the fiscal position, as a low growth
scenario would mean lower revenues, without any commensurate decline in expenditure due
to the government’s focus on inclusive growth (reflected in increased expenditure on food
and fertilizer subsidies) and the demands of a popular democracy. Oil subsidies could also
remain high, if global crude oil prices remain anchored at USD100/barrel, thereby providing
little respite on the expenditure front, despite a lower growth scenario. This potentially could
push up the centre’s fiscal deficit to 6.0% of GDP in FY12/13, from a likely 5.5% of GDP in
FY11/12.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
What if India’s GDP growth trend slows to 7%?
While we note a trend GDP growth rate of 8-9% has been embedded in investor
expectations of India’s earnings growth/ROE trajectory, policy uncertainties, the
conflicting demands and compulsions of a popular democracy on the government
and India Inc’s growing discouragement, are increasing the risk of India’s -
medium term - GDP trajectory slowing towards 7%. In this note we have
attempted a sensitivity analysis to assess the impact of slowing growth on BSE
Sensex earnings and answer questions associated with a slowing GDP growth
trend. However, a 7% GDP growth trajectory is not our base case scenario with
our economists forecasting a 8% average GDP growth over next two years.
What will be the impact of a slowing growth on India’s valuation multiples?
We confess that India is beginning to lose some of its investor goodwill
accumulated over the past five to seven years. The perception of a slowing GDP
growth trend, could result in a further de-rating of the country’s valuation multiple
and a compression in its average premium to MSCI Asia nudging investors into an
even more cautious posture. Over the past few months we have seen a 260bps
compression in India’s PE valuation, driven by rising risk aversion (due to global
factors) and worries over policy uncertainties. While it is difficult to quantify the
extent of future valuation compression, we would think that valuations could get
reset to a level of 11x to 12x, which prevailed in the late nineties and first half of
previous decade (corresponding fair value range of 14500-16000 for the Sensex).
Moderate 3% downside risk to Sensex FY13 earnings
Our India research team’s extensive bottom up sensitivity analysis suggests a
downside of 3.2% to our current BSE Sensex earnings expectation for FY13,
taking earnings growth for FY13 to 12.5% from our current estimates of 16.3%.
While the downside risk to FY13 earnings sensitivity may appear muted, this could
be attributed to our analysts having already cut FY13 earnings estimates by 12%
since Apr’11 (relative to a 9% cut for FY12).
Highest downside risk to Capital Goods, Autos, Telecom
Capital Goods/Construction companies could witness the sharpest downside
risk (-11%) driven by 13% drop in L&T’s earnings and 11% drop in BHEL’s
earnings. Autos earnings could be impacted by ~7% led by Maruti (12%), M&M
(8%) and TAMO (6%). Telecom earnings could decline by 6%. For Banks, slowing
GDP growth would lead to asset quality concerns, with our Banking analyst
getting more worried on asset quality in the power and SMEs segments.
However, banks could likely restructure their power assets rather than classifying
them as NPLs which may lead to valuation multiple contraction.
What could allay downside concerns?
Bold policy actions on state electricity board reforms (power tariff hikes),
addressing supply side bottlenecks in coal, preventing any runaway increase in
fiscal deficit (through raising fuel and fertilizer prices) and most importantly
assuaging India Inc’s high pessimism, remain critical, in our opinion, to ensuring
that India’s investor goodwill is not impaired. Expectations of slowing global
growth and increasing regulatory focus on commodities may well be a silver lining
for government finances, if commodity (particularly oil) prices continue to ease.
What if GDP growth trend
slows to 7%?
With India’s real GDP growth averaging 8.4% over past five years, a trend growth rate of 8-
9% has now been embedded in investor expectations. We think this is not a wrong
assumption with India’s savings rate averaging 34%, forming the bedrock of the 8% growth
trajectory.
India has generated considerable attention as an investment destination driven by its unique
domestic consumption model, attractive demography and low correlation with global GDP
growth. Barring the global economic crisis years (2008-2009), India’s GDP growth has
averaged 9% over past 5 years. The 8-9% GDP growth trajectory has been broadly
embedded in India’s earnings growth/ROE trajectory expectations and as a corollary its
valuation bands. This trend has now embedded expectations of a structural BSE Sensex
earnings growth expectation of 20 to 25%, which has manifested in the country commanding
an average valuation premium of 300bps over the benchmark MSCI Asia.
While we are not forecasting a slowdown in India’s long term GDP growth trajectory, we
believe that policy uncertainties, the conflicting demands of a popular democracy on the
government (particularly during busy state election years) and India Inc’s rising despondency,
are increasing the risk of India’s - medium term - GDP trajectory slowing towards the 7%
level from the average 9% over past five years (ex- crisis period). These concerns can be
alleviated and the risk reduced considerably if (1) global commodity prices come off (2) clarity
emerges on coal supply bottlenecks and revision in power tariffs by state electricity boards
(3) return of India Inc’s business confidence and inclination to invest. Currently, consumption
from the Indian hinterland is doing the heavy lifting for the Indian economy. The
Government’s politically strategic inclusive growth initiatives are driving prosperity in the
Indian hinterland.
While investors are still hopeful over India’s attractive long term fundamentals, we are now
increasingly being asked about the impact of a slowing GDP trajectory on earnings growth,
sector positioning and valuation multiples.
We confess that it appears India is beginning to lose some of its investor goodwill
accumulated over the past five to seven years from its conscious attempt to improve its
public as well as private balance sheets, the government’s successful, preemptive efforts in
stimulating the domestic economy during the global economic crisis and its vibrant
investment story (domestic fixed capital formation grew at a CAGR of 16% over FY04-08).
In this note we have attempted to answer most of the questions we are being asked by
investors in the context of a slowing GDP growth trend. We reiterate that a 7% GDP growth
trajectory is not our base case scenario with our economists forecasting a 8% average GDP
growth over next two years. Bold policy actions on addressing supply side bottlenecks in
coal, preventing any runaway increase in fiscal deficit (raising fears of a crowding out of
private sector) and most importantly reducing India Inc’s high despondency remain critical to
ensuring that India’s investor good will is not impaired.
What will be the impact of slowing growth on BSE Sensex
earnings
Limited risk to FY13 Sensex earnings..:
Our India research team’s extensive bottom up analysis suggests a downside of 320bps to
our current BSE Sensex earnings expectation for FY13, taking earnings growth for FY13 to
12.5% from our current estimates. BSE Sensex aggregate EPS in FY13 would amount to
1323- relative to our current expectation of 1367.
… as analysts have already cut FY13 earnings estimates sharply : While the risk to FY13
earnings may appear muted, this could be attributed to our analysts cutting FY13 earnings
estimates aggressively. Our analysts have cut earnings expectations for FY13 by 12% since
Apr’11 (relative to a 9% cut for FY12). In addition with ~40% of Sensex earnings driven by
global factors (IT, Oil&Gas, Pharma, JLR, Corus etc.), the impact of a domestic slowdown is
tempered.
We see highest risk to earnings in Capital Goods, Property,
Autos, Telecom and Banks
Bottom up analysis of our analysts’ estimates suggest that in case of India’s GDP growth
slowing down to 7% purely on domestic factors, Capital Goods, Autos, Telecom and Banks
exhibit the highest downside in earnings from current levels:
Earnings of Capital Goods/Construction companies could witness the sharpest
downside risk (-11%) driven by 13% drop in L&T’s earnings and 11% drop in BHEL’s
earnings. Our sector analysts have factored in a 5%/10% decline in revenues of
BHEL/L&T, mainly as could slow down, particularly driven by deceleration in slow
moving orders. However, the impact of slowing order book growth could be partially
moderated by lower global commodity prices.
Autos earnings could be impacted by ~7%(in case GDP growth slows down to 7%),
with Maruti likely to see sharpest decline in FY13 earnings of 12%, as it could get dually
impacted by (i) significantly lower volume growth of just 9% (vs. our base case of 14%)
and (ii) a 60bps hit on EBITDA margins due to expectations of weaker INR vs. JPY.
Mahindra & Mahindra could be impacted by 8% as its UV and small CV segment could
likely see a sharp cut in volume growth, even as tractor growth should not be materially
impacted. For Tata Motors, domestic operations could take the biggest hit in the auto
pack (with MHCVs expected to de-grow by 8% and LCVs growth falling sharply by 10%
points), but the overall impact on earnings is moderated to just -6% due to no change to
its international operations (i.e. JLR, accounting for 65% of TAMO’s consol EBITDA).
Telecom’s (represented by Bharti only) earnings could face a downside risk of 6%, as
there could be a decline of 200bps in minutes growth and a shrinkage in tariff hike from
3.5% to 2.5%. Additionally, Bharti’s finances will also be hit by higher interest costs, on
account of depreciating INR.
For Financials, there could be a downside risk of 6% to our base case estimates, with
ICICI Bank most at risk (-10%), and HDFC Bank being least affected (-3%). Our banking
analyst Manish Karwa notes:
In case of slower economic growth, we believe that following could happen – (a) loan
growth could decelerate by ~200-300 bps (vs. base case of 18%), (b) on margins, we
believe that the industry is playing very rationally and despite a slower growth, we do
expect the system to make reasonably strong margins, (c) Asset quality will however be
the biggest concern and we are now getting slightly more worried on this especially in
the power and SMEs segments. While power sector continues to be plagued by
problems of its own, it is actually the SME/mid market segment which may see higher
delinquencies. SMEs roughly account for about 25% of the loan book, wherein, likely
NPLs could be 10-15% higher than general expectations. However, the impact of
slowdown may be staggered. Further, we believe that banks will most likely go for
restructuring their power assets rather than classifying it as NPLs. Thus, while reported
NPLs may not rise much, restructured asset are likely to be higher which may lead to
multiple contraction (d) Despite a slowdown, we are not much concerned on retail loans
and loans to large corporates which roughly constitute about 50-55% of total loans in
context of asset quality, but reiterate that growth may be slower in these segments.
IT Services, Oil & Gas, Utilities, Pharma and FMCG likely to be
least impacted
We do not see any meaningful impact on IT Services or Oil & Gas companies, as our
analysis envisages endogenous growth slowdown only. However, among other sectors
we see Utilities, FMCG and Pharma to be impacted only modestly:
For Utilities we expect no impact on earnings as India continues to remain in power
deficit mode with demand far outstripping the supply (despite robust growth of 9-10% in
electricity production over last 3 quarters). The current power deficit stands at ~10%.
Therefore, unless demand growth moves down to zero (a highly unlikely event, even if
GDP growth slows down to 7%), India will continue to remain power deficient, and
hence there should not be any impact on power utility companies in Sensex. Our Utilities
analyst Abhishek Puri notes further that:
We estimate that under demand slowdown, power spot rates could well settle at INR
3.5/unit. The most impacted players from demand slowdown would be marginal
contributors to the sector, or merchant power projects, as the spot tariffs could be
impacted negatively on reducing power deficit- highest exposure in FY13E will be for
JSPL (1.8GW), JSW Energy (1.6GW) and Adani/Lanco Infra (1.2GW) – but the impact on
JSPL could be moderates given that it is the lowest cost producers.
For Coal India, we do not foresee a decline in volume growth, and impact, if any, could
probably be through lower e-auction prices, bringing down Coal India’s earnings by 1%
only.
For FMCG too, the likely impact on earnings is limited to -2%, as ITC’s cigarette sales
remains relatively inelastic to economic cycles, while for HUVR, the margin pressures
could be partially offset by lower raw material costs.
Pharmaceuticals earnings could also remain insulated from domestic headwinds (with
~55% of Sensex pharma companies’ revenue coming from export). On domestic
revenue too, demand is largely secular in nature and independent of economic
conditions and hence we only see a likely 2% downside risk in earnings.
Impact on consumption, investments and BoP
Our calculation suggests that for a 7% real GDP growth, private consumption growth would
have to moderate to 5% (from a likely 7% growth in FY11/12) and investment growth should
ease to 7% (from an already low growth expectation of 8.0% in FY11/12). Exports and
imports growth should also moderate by 7-8%, with a likely bigger slowdown in imports
component, to reflect weak momentum in the domestic economy. As a result, trade deficit
should narrow by 50bps to 7.0% of GDP, helping the current account deficit to also shrink
somewhat and thereby supporting a modest appreciation of the rupee from current levels.
However, in a low growth scenario, there would be lesser scope for the rupee to appreciate
sharply, as foreign capital inflows (both FDI and portfolio investment) would be expected to
remain muted, compared to its historical trend.
Impact on inflation and the likely response of RBI
Intuitively, a low growth scenario also implies a reasonably lower inflation outturn through the
course of FY12/13. However we are not factoring any sharp deceleration in WPI inflation,
even under a 7% growth assumption. Given that part of India’s inflation has become
structural in nature (owing to supply bottlenecks in both infrastructure and agricultural sector)
and given our assumption that global crude oil prices would not fall sharply below the
USD100/barrel mark, WPI inflation in such a scenario would only moderate close to the RBI’s
comfort range of 5-5.5%, but unlikely to dip substantially below this level. Bank credit growth
would slow down to around 15%, reflecting weak economic activity, but unlikely to fall to a
single digit level owing to continued borrowing demand from oil marketing companies (with
government subsidy payments compensating loss making OMC’S with substantial lags). In
such a low growth-stable inflation scenario, RBI would have the window to entertain rate cuts
of 100-125ps, to bring the real policy rate close to the neutral level, in our view.
Impact on fiscal deficit
However, the biggest negative impact would be on the fiscal position, as a low growth
scenario would mean lower revenues, without any commensurate decline in expenditure due
to the government’s focus on inclusive growth (reflected in increased expenditure on food
and fertilizer subsidies) and the demands of a popular democracy. Oil subsidies could also
remain high, if global crude oil prices remain anchored at USD100/barrel, thereby providing
little respite on the expenditure front, despite a lower growth scenario. This potentially could
push up the centre’s fiscal deficit to 6.0% of GDP in FY12/13, from a likely 5.5% of GDP in
FY11/12.
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