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August 2012

CRISIL Insight

10

8
8.0

Inflation

Growth
5.5

5 FY 11 FY 12

FY 13

India: Macroeconomic Outlook Revision 2012-13

CRISIL Insight

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Last updated: April 30, 2012

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India: Macroeconomic Outlook Revision 2012-13

Key Messages

CRISIL Research has cut Indias real GDP growth forecast for 2012-13 to 5.5 per cent from its earlier forecast of 6.5 per cent. The average WPI inflation forecast has been raised to 8.0 per cent from 7.0 per cent released earlier. The downward revision in Indias growth forecast factors in the adverse impact of rainfall deficiency (an expected deficiency of 15 per cent for June-September 2012, as per Indian Meteorological Department) and worsening of the Euro zone growth outlook (a revision in 2012 growth forecast to -0.6 per cent by Standard & Poors relative to the earlier forecast of zero per cent). Despite slowing growth, CRISIL Research has revised up its average WPI inflation forecast for 2012-13 to 8.0 per cent to reflect the adverse impact of deficient monsoon on food inflation. We now expect the fiscal deficit to worsen to 6.2 percent of GDP in 2012-13 from our earlier estimate of 5.8 per cent. The increase in the fiscal deficit to GDP ratio largely reflects lower revenue growth as a result of slowing GDP growth. In case of a substantial fiscal stimulus to the economy, the fiscal deficit to GDP ratio could worsen further. The rupee is now expected to settle around 53 per US$ by March-2013 compared to our earlier forecast of 50 per US$. Given the worsening of the Euro zone economy as well as domestic growth slowdown, we now expect the Indian economy to attract lower foreign capital inflows compared to our earlier estimate. The revised growth forecast assumes that the stretched fiscal situation will limit the ability of the government to give a generous stimulus to the economy. If it does so, then growth will go up but so will fiscal deficit. Similarly high inflation will tie the hands of the Reserve Bank of India (RBI) in aggressively cutting rates to stimulate the economy. Swift policy action to solve issues related to mining, land acquisition and speedy clearance of projects can create upside to the growth projection.

CRISIL Insight

India: Macroeconomic Outlook Revision 2012-13

After we revised Indias macroeconomic forecast for 2012-13 in June, two key risks to the economy have emerged: First, the deficient monsoon; second, worsening of the Euro zone economic outlook. We now forecast Indias real GDP growth in 2012-13 at 5.5 per cent, a percentage point lower than our June estimate of 6.5 per cent. Our forecast assumes

Monsoon deficiency at 15 per cent for the full south west monsoon season (June-September) as indicated by Indian Meteorological Department (IMD) on August 2, 2012 Euro zone growth in 2012 at -0.6 per cent, which is Standard & Poors (S&P) revised forecast compared to its earlier forecast of zero per cent.

The revised growth forecast for India does not take into account any substantial fiscal stimulus that may be provided to the economy to arrest and reverse a growth slowdown. A fiscal stimulus may create some upside to industrial and services growth. Upside to growth can also arise from sorting out policy-related issues in mining and power sectors. In contrast, the key downside risks to the revised growth outlook arise from

Monsoons deficiency of more than 15 per cent for the full season as indicated by IMD. In that case, agricultural production could be hit much harder. A deeper recession in the Euro zone in 2012 with the regions economy shrinking by 1.0 per cent, which is the worst-case scenario projected for the Euro zone by S&P. This will hurt Indias exports and capital inflows further.

Table 1 India economic outlook 2012-13 2012-13 2011-12 Actual Agriculture GDP Growth Industry Services Total Inflation Interest rate Exchange rate WPI Average 10- yr G-Sec (March-end) Re/US$ (March end) 2.8 3.4 8.9 6.5 9.0 8.8 51.2 Forecast released in Jun-12 3.0 5.0 8.1 6.5 7.0 8.0-8.2 50.0 Aug-12 0.0 3.6 7.6 5.5 8.0 8.0-8.2 53.0

Fiscal deficit % of GDP 5.7 5.8 6.2 Source: Central Statistical Organisation (CSO), RBI, Budget documents, Ministry of Finance, and CRISIL Research

According to the IMD, rainfall for the south-west monsoon season is likely to be around 15 per cent deficient close to 20 per cent deficiency recorded in June-July. Even if there is a partial recovery in rainfall in the coming weeks, an overall deficiency of 15 per cent would imply that 2012-13 will end up as a drought year and will result in a substantially lower sowing not only in the kharif season, but will also adversely influence the rabi crop. As a result, agriculture GDP would not grow this year and would record zero per cent growth compared to our earlier estimate of 3 per cent under the assumption of normal monsoon.

Depending on the quantum of rainfall deficiency and its distribution, which will become clearer towards the end of the monsoon season, agriculture production this year could even be lower than last year. According to CRISIL Researchs Deficient Rainfall Impact Parameter (DRIP), the hit to agriculture at a national level on the basis of the rainfall pattern till date is almost as bad as in 2009 (Box 1, and Monsoons 2009 situation yet again? CRISIL Insight, July 2012). The weak performance of agriculture will rub off on industry and services given the inter-linkages among them. Overall, a monsoon failure resulting in a severe drought accounts for a downward revision of around 0.7 percent out of a total downward revision of 1 percentage point to Indias growth forecast. On the global front, our forecast takes into account the worsening of the Euro zone economy. According to S&Ps revised forecast, the Euro zone economy will shrink by 0.6 per cent in 2012 compared with the previous forecast of zero per cent growth. The deterioration in the economic outlook for Europe, including a recession-hit UK, implies that Indias IT/ITES sector, which exports around 20-25 per cent of its exports to the region, will experience a slowdown (for details see Indias Euro Connection: Growth Scenarios, CRISIL Insight, June 2012). Indias merchandise exports (clothing, iron & steel, electronics and gems & jewellery) too will decelerate further (Euro zone accounts for 15 per cent of Indias total exports). The above forecasts do not take into account a substantial fiscal stimulus that might be provided to the economy as growth slips below 6.0 percent. During 2008-09 and 2009-10, rainfall was deficient, with 200910 being an all-India drought year and agriculture growth for two years averaging at 0.6 per cent (Table 2). During these years, the government had announced farm loan waivers in excess of Rs 40,000 crores in addition to other stimulus measures such as extension of Mahatma Gandhi National Rural Employment Guarantee Scheme to the entire rural India, and indirect tax cuts. In addition, increases in wages of public sector employees through implementation of Sixth Pay Commission also took place in these two years. While the government has began to announce drought-relief measures, we do not envisage a large fiscal stimulus in 2012-13 similar to 2008-09 and 2009-10 given the strain on central governments finances. However, swift policy action on issues related to mining, land acquisition and speedy clearances of projects can create some upside to our growth projection of 5.5 percent for 2012-13.
Table 2: Real GDP growth (year-on-year%) Agriculture 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13F Note: F CRISIL Forecast Source: Central Statistical Organisation 4.2 5.8 0.1 1.0 7.0 2.8 0.0 Industry Services 12.2 9.7 4.4 8.4 7.2 3.4 3.6 10.1 10.3 10.0 10.5 9.3 8.9 7.6 GDP 9.6 9.3 6.7 8.4 8.4 6.5 5.5

CRISIL Insight

Although the growth forecast has been revised downward, WPI inflation forecast has been revised up to 8.0 per cent to reflect the higher-than-anticipated increase in food inflation. Also, a weak rupee will continue to offset the gains from lower global crude oil, commodity and metal prices, and keep the cost of imported items high. On the flip side, lower GDP growth in both India and the Euro zone will result in a decline in manufacturing inflation. The flaring up of food inflation will, however, raise inflationary pressure. Our inflation forecast assumes around 8-10 per cent pass-through of international crude oil prices into domestic retail fuel prices. Factors that will maintain upward pressure on inflation include the increase in minimum support price for food crops, a potential revision in electricity tariffs, and an increase in diesel prices. Manufacturing inflation will remain low due to moderating demand-side pressures on inflation arising from the slowdown in growth. With lower pricing power of corporates, core inflation, reflected in both nonfood manufacturing inflation and CRISIL Core Inflation Indicator (CCII), should continue to remain below 5.0 per cent. With lower GDP growth, government revenue growth too will be lower than estimated earlier, which pushes our fiscal deficit forecast to 6.2 per cent from the earlier forecast of 5.8 per cent of GDP. This deficit forecast does not take into account any substantial stimulus that may be given to the economy to boost growth. Given the higher fiscal deficit and, consequently, higher government borrowings, the pressure on the 10-year G-sec yield would remain high. We expect the yield at around 8.0-8.2 per cent by March-end 2013, even if the repo rate is cut by further 75-100 basis points by the RBI in the rest of the fiscal year. The rupees appreciation against the dollar from current levels to around 53 per US$ by March-end 2013 would be supported by easing of the current account deficit in 2012-13 to nearly 3.1 per cent of GDP, from 3.6 per cent estimated earlier. Lower import growth compared to our earlier assumption, due to a fall in Indias GDP growth as well as softening of international oil prices, would reduce the import bill. Despite a slight worsening of the Euro zone situation, India would continue to remain attractive to foreign investors due to 1) Attractive valuations of Indian equity markets because of the sharp rupee depreciation and correction in equity prices. 2) Over 400 bps growth rate differential that India will maintain with the West, despite growth slowdown. However, given the worsening of global and domestic growth outlook, we now expect the Indian economy to attract less foreign capital inflows than expected earlier. As a result, we now expect rupee to settle around 53 per US$ by March-end 2013 compared to our earlier forecast of Rs 50 per US$. At the current juncture, both monetary and fiscal policies are constrained to revive growth in the immediate run. The upside risks to inflation and limited ability of lower interest rates in propping up growth implies lower room for monetary loosening. The fiscal policy can create some upside to our projected growth scenario by 1) boosting investment expenditure 2) swift policy action to solve issues related to mining, land acquisition and environmental clearances, and speedy clearance of projects. It will also be critical to raise the administered fuel prices to reduce subsidies and create fiscal room for expenditure related to drought-relief measures. Boosting investor confidence in the governments resolve to tackle both short-term and long-term challenges to sustain growth, especially demonstrating its ability to push through key reforms related to land, labour, taxation and government expenditure, would hold the key to raising Indias growth prospects over the medium run.

Box 1: Relationship between rainfall, DRIP and agriculture GDP As per the long-range forecast provided by the IMD for the second half (August-September) of the south west monsoon season, India is expected to receive 91 per cent of the normal rainfall (with an error of +/- 8 per cent). As of August 1, 2012, the rainfall deficiency at 19.0 per cent below normal is similar to the levels in 2009 - an all-India drought year (Figure 1). Rainfall deficiency is over 10 per cent in most of the major states. States with high rainfall deficiency include Haryana, Gujarat, and Punjab, which have received 71.0 per cent, 66.6 per cent and 66.5 per cent below normal rainfall, respectively. Figure 1: Overall rainfall deviation as of July-end (% from normal)

5.0 0.0 -5.0 -10.0 -15.0 -20.0 -25.0

3.4

-2.2

-1.8 -6.4

-19.3

-19.0

2007

2008

2009

2010

2011

2012

Source: Indian Meteorological Department CRISIL Research measures the impact of deficient rainfall on agriculture output through Deficient Rainfall Impact Parameter (DRIP) that was developed in 2002. DRIP is based on the premise that both the availability of irrigation and the level of precipitation affect crop production. DRIP is a better indicator than percentage deviation of rainfall from normal, as it captures the deficiency of rainfall (measured as deviation from normal) as well as the vulnerability of a region (measured as percentage of un-irrigated area). These two variables are combined to compute DRIP in the following way: %UNIRRij x %DEFj DRIP = ----------------------100 where %UNIRRij: Percentage of un-irrigated area under crop i for state j %DEFj : Percentage deviation of actual rainfall from normal for state j The higher the value of the DRIP Index, the greater is the (adverse) impact of deficient rainfall. The DRIP scores are also highly correlated with agriculture growth (Figure 2) This year, the deficiency in rainfall in June-July is 19 per cent. This has affected sowing of the kharif crop (down by around 10 per cent, as on July 27, 2012, as against the same period in the previous year). DRIP scores show that the impact of the deficient monsoon so far this year on foodgrain output will be similar to what it was during the 2009 drought.

Continued

CRISIL Insight

Figure 2: Food grain DRIP score as of July-end and Agricultural Growth

Food Grain DRIP 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0 FY 08 FY 09 FY 10 FY 11 FY 12 FY 13 Real Agricultural GDP growth

Note: DRIP scores are as of July end; Agricultural GDP growth rates are for the fiscal years; Expected agriculture growth for FY13 Source: Central Statistical Organisation, CRISIL Research According to the DRIP scores calculated using rainfall data available till August 1, 2012, deficient rainfall has adversely impacted Gujarat, Rajasthan, Karnataka, Maharashtra, and Haryana. The worst-affected crops are bajra, groundnut, tur, jowar, and maize.

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