India Economics - The Big Picture: Bridging the gap :: IIFL

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India Economics
The Big Picture: Bridging the gap 
• Widening current account—don’t blame over-consumption: The widening of India’s current account
deficit is often, but incorrectly, attributed to ‘over-consumption’. Sharply lower invisibles surplus is the
biggest cause of the rise in India’s current account deficit over the past year. India’s merchandise deficit
has actually declined in the 12 months ending June 2010 even as the current account deficit (as % of GDP)
widened over 1pps as invisibles surplus declined almost 2pps.
• Capital controls unlikely: The recent surge in portfolio flows into India and prospects of its continuance after
the expected QE II, together with a sharp rise in INR, have given rise to questions on the possibility of capital
controls in India. In our view, India is unlikely to impose any capital controls, given: a) the large current account
necessitating large capital inflows to fund the gap; b) the decline in FDI, which has increased India’s reliance on
portfolio flows and ECBs; c) the government’s disinvestment programme; and d) India’s FX reserves, though
large in absolute terms, are not as large as they used to be, giving RBI the scope to build FX reserves.
• Monetary policy—headed for a pause, not an end: After a 25bps hike in policy rates on 2 November,
we expect RBI to take a pause in its calibrated policy-tightening stance. However, we expect RBI to only
pause, and don’t believe this to be necessarily the ‘end’ of policy tightening, as inflation—both in goods
and real assets (real estate)—is high. We believe RBI will pause as long as inflation continues to track its
projected trajectory (6% WPI by March) and asset markets do not show an abnormal rise.
• Marginal reduction in fiscal deficit ex 3G likely: Tax collections have been very buoyant this year, gross
tax revenues up 27% during April–August, as against the full-year budget estimate of ~20% growth. For the
full year, we expect tax collections to exceed budget estimates, growing ~24% YoY. However, the buoyancy
in tax collections and the 3G bonanza, will in our view, be almost entirely used up by additional
expenditure, rather than helping contain the fiscal deficit. Excluding the one-off 3G bonanza, fiscal deficit
will likely be 6.5% for FY11, only marginally lower than last year’s 6.9%.