Macro Stability Indicators Continue to Improve Gradually: Morgan Stanley Research,

Key Macro Indicators – What Are They Saying?
Positive

• Industrial production growth accelerated to 2.5% in March, led by improvement in capital goods
• Private projects under implementation picked up a bit in QE March; public sector projects remained steady
• WPI inflation decelerated to a 41-month low of below 5% in April
• CPI inflation decelerated for second consecutive month to 9.4% in April
• Rural agriculture sector wages continue to show signs of moderation, though they are still high. Rural farm wage growth decelerated to 16.9% YoY for the three months ended Mar-13 from the peak rate of 22% during the three months ended October 2011
• 12-month trailing fiscal deficit has shown improving trend since Sep-12


Negative
• Export growth decelerated to 1.7%YoY in April; on a seasonally adjusted sequential basis, exports fell by 2.8% in April
• Trade deficit widened in April to US$17.8bn vs. US$10.3 bn in Mar, led by higher gold imports (up 138%YoY)
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Auto sales continued to decline in April
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Seaport traffic growth declined in April
• Corporate revenue growth decelerated further in QE Mar-13
• Credit ratio (rating upgrade to downgrade ratio by Crisil) remains low at 0.6x in 2H F2013

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Macro Stability Indicators Continue to Improve Gradually
Growth: Capex Activity Stabilizing; Exports Decelerated, in Line With Soft Global Growth
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Domestic demand: Industrial production growth for Mar-13 accelerated from the previous month, and growth mix showed encouraging signs as capital goods improved for second consecutive month. Consumption indicators, particularly discretionary spending, e.g., auto sales, have remained weak. Within investment, for the quarter ended Mar, private projects under implementation increased slightly in YoY terms after nine quarters of deceleration, and government projects under implementation remained steady.
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External demand: Export growth decelerated to 1.7% YoY in Apr vs. 7% YoY in Mar 2013. On a seasonally adjusted basis, exports declined by 2.8% MoM in Apr-13. Even after the decline in April, on a seasonally adjusted cumulative basis, exports have increased by 15.5% from the trough in Jul-12. The deceleration in export growth in YoY terms is consistent with the weaker export growth reported earlier by Korea and Taiwan, reflecting the soft patch in global growth which is expected to prevail through 2Q.
Liquidity Conditions: Market Rates Down to 2½-year Low
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Monetary indicators: Market-based rates have declined to a 2½-year low as growth remains weak and inflation has decelerated. Market-based rates at both the long and short ends have declined – 3M commercial paper and certificate of deposit rates have declined to a 2½-year low, and yield on long-end bond (10Y) is near a three-year low. Indeed, liquidity conditions are showing some improvement, as gap between deposit and credit growth has narrowed, with deposits growing 13.5%YoY and credit growing 15% as of May 3.
Macro Stability Indicators: Continuing to Improve Gradually
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Inflation: WPI inflation decelerated significantly, to 4.89% in Apr vs. 5.96% in Mar, reflecting the deceleration in food inflation (vegetable prices) and lower global commodity prices. This is the first time since Nov 2009 that WPI inflation has slowed to below 5%. Deceleration in WPI is in line with softening PPI inflation in DM and EM economies due to weaker industrial commodity prices. Inflation as measured by the CPI index, which we believe is more important, also decelerated for a second month, to 9.4% YoY in Apr vs. 10.4% in Mar. Non-food inflation decelerated, albeit marginally, to 8.2% in Apr vs. 8.6% in Mar. Old CPI (IW) inflation decelerated to 11.4% YoY in Mar vs. 12.1% in Feb.
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Trade balance: The trade deficit for April widened to US$17.8bn (11.4% of GDP) vs. US$10.3bn (6.7% of GDP) in March as export growth decelerated and imports rose, led by a surge in gold imports. Trade deficit excluding gold declined by 6%YoY in Apr.
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Fiscal deficit: Total government expenditure growth slowed to 3.1%YoY in Feb vs. 13.8% in Jan. Total expenditure growth has been on a decelerating trend since Sep-12, and FYTD spending growth has moderated to 10.2%YoY. Apart from reduction in fuel subsidy, growth in expenditure ex interest and subsidy has slowed significantly. Indeed, growth in total expenditure ex interest and subsidy payments decelerated to 3.8% in Sep-Feb 2013 from 11.4% in Apr-Aug 2012. For F2013, the government is likely to achieve its revised fiscal deficit target of 5.2% of GDP, which would be a significant improvement from our tracking estimate of 6.1% in

Outlook
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Growth: We believe this will be a challenging cycle and recovery in growth will be only gradual. Moreover, the starting point of macro stability environment (inflation, current account deficit and high banking sector loan-deposit ratio) will constrain a consumption / domestic demand led recovery. As domestic demand growth remains constrained, we expect external demand and capex spending to play an important role in supporting growth. We expect GDP growth to recover from 4.5%YoY in QE Dec-12 to 6.3% in QE Dec-13.
Macro Stability Indicators
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Liquidity: We believe that interbank liquidity will continue to improve as inflation decelerates and deposit growth recovers with a lag. We expect market-based rates to decline by 100bps over the next 12 months.
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Inflation: While WPI inflation has been decelerating since Oct-12, CPI inflation remains high. As we have been highlighting, we believe the trend in inflation expectations is better represented by CPI inflation in this cycle, and thus we are more closely tracking CPI inflation, which has started to decelerate over the past two months. We expect it to moderate further due to: (i) lagged impact of slower government spending growth, (ii) deceleration in rural wage growth, (iii) slower rise in global commodity prices, particularly for oil, also reflected in lower WPI, (iv) moderation in asset prices, particularly housing, and (v) slower growth in domestic demand. We expect CPI inflation to moderate further, to 6.5% by Mar-14 from 9.4% in Apr-13.
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Trade Balance: We expect trade deficit / current account deficit to narrow over the next 12 months, helped by i) gradual improvement in external demand from 2H 2013 that should boost export growth from 3Q13, (ii) recent government efforts to cut fuel subsidy burden to help moderate oil imports, (iii) softening commodity prices and (iv) moderation in CPI inflation which will becritical to reduce gold imports.
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Fiscal Deficit: The government has delivered on fiscal consolidation in F2013, helped by significant deceleration in government spending growth. We believe that the government will likely stay on course in F2014, too. We expect the central government deficit to be 5% of GDP vs. our estimate of 5.2% of GDP in F2013.
Bottom Line: After almost three years of slowing economic growth and elevated inflation, we are now seeing early signs of a reversal in the stagflation-type environment as policy makers are beginning to take steps to correct the bad growth mix (high fiscal deficit and low investment). We expect the initial phase of recovery to be driven by an improvement in growth mix and productivity growth rather than a big rise in investment to GDP or headline GDP growth. As the macro stability environment (inflation, current account deficit and high banking sector loan-deposit ratio) improves, it should set the stage for a stronger recovery in growth.