With the start of a new financial year, in this update, we present our conjectures of macro-economic developments during the course of the year. A comprehensive take is provided on a variety of macroeconomic variables – the expected direction and magnitude of movement, factors influencing them, and overall implications of these changes. FY 2013-14 will be a year of mild revival for the Indian Economy…
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Forecast for the Indian Economy 2013 – 2014
FY14 will be a year of mild revival
While some pressures would continue to persist and perhaps weigh on growth prospects, the ultimate picture measures as an improvement over the year gone by. The low statistical base effect will help significantly to present relatively better numbers for certain economic variables given that the FY13 performance has come with virtual industrial stagnation, high inflation, and conservative policies.
In brief, we expect growth to pick up, albeit gradually but will continue to remain below the higher average growth trajectory of the last five years. The uptick in growth would be driven by a gradual revival in industrial production, stable agri-sector activity, and steady services sector growth. Supply-side constraints would ease to some extent as investments shelved in the last year (both government and private sector) begin to churn and flow into the economic cycle.
With easing inflation, the tough choice of balancing the trade-off between growth and inflation will be less pressing giving way to the emergence of what could be termed as a cautious growth-oriented pro-cyclical monetary regime. However, a clear picture will emerge only in the second half of the year. Capital markets in a more investment-favorable environment are also expected to receive a much-required boost.
The external sector will be pressurized during the year and the challenges faced in FY13 such as rising current account deficit will continue to play in the mind of the government and RBI while formulating policies. However, it is expected that there would be some improvement in the CAD and the continued flows of foreign capital will keep the rupee largely stable – assuming that geopolitical tensions do not deteriorate and global economic conditions remain where they are, with the recovery process also being cautious.
The update sequentially looks at expectation on overall growth, the performance of the agricultural and industrial sectors, banking and capital markets, fiscal thoughts, and external sector scenarios likely to emerge.
INDIAN ECONOMY GDP GROWTH TO SEE MODEST IMPROVEMENT
With a recovery in manufacturing activities, economic growth expected to pick this year…
Moderation of growth of the Indian Economy over the past year is a pertinent concern on the weakening of economic fundamentals for the country. Structural bottlenecks, slow policy movement, stubborn interest rates on account of high inflation, declining exports, low non-food credit growth, declining industrial growth and subdued demand for both consumption and investment has led to the systematic decline in the overall economic growth of the country in FY13 which will be at the level projected by the CSO at 5.0%. Growth has hence been held up this year on both the supply and demand fronts which have impeded any pick-up inactivity. It may be recollected that we started the year with an assumption of upwards of 7.5% GDP growth for the year and the path followed has been quite different from what was expected.
Growth has consistently moderated quarter after quarter, from 5.5% in Q1 FY13 to 5.3% in Q2 FY13 and to 4.5% in Q3 FY13. The signs available for the fourth quarter do not look very different and a significant pickup is not expected.
The CSO in its advance estimate indicates growth to settle at 5.0% in FY13; this would primarily be driven by growth in services. Given that agricultural activity has taken a setback against delayed monsoons, and industrial activity with limited capital investments has been subdued so far, growth expectations from these sectors are not high.
We expect growth to revive gradually going into the next fiscal; with an estimate for GDP growth of 5.9% – 6.0% in FY14. This expectation would ride on the back of normal monsoons giving a good harvest, an increase in investments in a favorable interest rate regime, and gradual recovery in industrial production. Above all, it is assumed that the government will expedite projects that have been held up and also start spending on capital projects, which has hitherto been held up on account of fiscal constraints. This will also be supported by affirmative action by the RBI, though the timing could be more during the second half of the year.
Further, it is assumed that the government will focus more on policies that do not require legislative approval in order to revive the growth process and that while one can hope for important bills to be moved in the Parliament, the assumption here is that this may not happen and in terms of the policy, the situation would largely be a status quo.
Agriculture to revert to normal trajectory
Harvest to be strong, against the back of normal monsoons and pro-farm pricing announcements…
The eleventh five-year plan (2007-12) witnessed an average annual growth of 3.6% in the agriculture and allied activities sector when compared with a target of 4.0% during the period. Growth in this sector has not only fallen short of the said target but has also been highly uneven. Growth in FY11 was as high as 7.9%, after near-stagnation in the previous two years, followed by lower growth rates in FY12 and FY13.
Agricultural production has been adversely impacted by delayed and uneven monsoons in FY13. Production of all major agro-commodities such as food grains, oilseeds, cotton, and sugarcane have witnessed negative growth; in particular, food grains production is expected to decline by 3.5% in FY13.
With the revised food security bill proposed recently, the requirement of food grains is estimated to be approximately 62 million tonnes. This requirement may be juxtaposed against the off-take of food grains by the government for public distribution and other various schemes (the highest off-take has been around 56 million tonnes in the last five years). This additional pressure can be met through two sources – progressive increase in procurement quantity of food grains over the years (approx. 64 million tonnes in FY13, as of Dec 2012) and from the current stock available with Food Corporation of India (62.8 million tonnes, as on March 1, 2013). The gap between requirement under Food Security and PDS (excluding other programs) could be in the region of 10-15 mn tonnes which can be met from the existing stocks with the FCI.
In terms of policy actions, we expect the government to continue with its pro-farm policy stance that it initiated in Union Budget 2013-14. The Budget proposed to set an agricultural credit target of up to Rs. 700,000 crore along with a continuation of lower farm interest rate (at 7.0%) and interest rate subvention of 3.0% for prompt paying farmers. The interest subvention scheme was further extended for crop loans borrowed from private sector scheduled commercial banks, thereby bringing more farmers under the purview of financial assistance. Going forward, we expect an increase in Minimum Support Prices (MSP) in the pre-election period to ensure remunerative prices to growers for their produce with a view to encouraging higher investment and production.
With several measures taken by the government to improve the flow of agri-credit, there is an expectation of more pro-active sowing that could boost growth in the agricultural sector to 3.0% in FY14. However, this growth remains contingent upon normal monsoons that impacts both sowing and harvest during the year.
Industry to revive
With an increase in consumption demand and higher capital investments, industrial activity is expected to improve…
The deceleration in industrial growth has been evident from the consistent low growth in the index of industrial production (IIP) observed over the months. The contraction in the mining and manufacturing sectors has been rather pronounced.
During FY13 (period Apr-Jan), overall industrial production grew by 1.0%, with mining registering negative growth and manufacturing registering near-zero growth. Electricity alone registered a robust growth of 4.7% and was the prime driver of IIP; this too appears to have lost steam in February, going by production numbers of the core industries.
Weakness in production in the manufacturing sector has further, been accentuated by volatility in capital goods production consequent on a lower level of capital investments. Gross fixed capital formation (GFCF, used as a proxy to investments) in FY13 (Apr-Dec) stood at 29.7% of GDP, lower than 31.0% in the corresponding period in FY12. Capital goods production has accordingly contracted in FY13 (by 9.3% during the period Apr-Jan).
We expect industrial activity to pick up in FY14 and grow by 4.0 – 5.0% with mining projected to grow by about 2.0%, electricity by 7.0%, and manufacturing activities in the range of 4.0 – 5.0%. This improvement in the industrial sector would be aided by an increase in government approvals for project investments that are currently in the pipeline and recovery in exports as global demand picks. Also, the two successive low base years will provide some modicum of buoyancy. Higher farm incomes and lower interest rates are expected to improve household spending, thereby providing the demand-side push to industrial production as private consumption revives. The period post-August would be critical for the fructification of these numbers as consumer spending pick up normally at this time.
Moderation in inflation to continue in FY14
Average annual inflation is likely to ease further in FY14 on account of a decline in food inflation due to the high base effect and assumption of normal monsoons that will ensure a normal harvest. The easing of core inflation due to lower/stable domestic and global demand conditions to put some downward pressure. However, the tendency for MSPs to be increased every year, will continue to exercise pressure on food prices, and hence will come in the way of inflation moderation. Also, the stance on diesel and LPG subsidy will have a bearing on the movement in prices of fuel prices.
After two years of high inflation in FY11 and FY12, the overall inflation on average annual basis moderated to 7.4% in FY13 (Apr-Feb). High food inflation (9.9%) and fuel inflation (10.4%) have kept upward pressure.
The higher prices of food articles are attributed to supply-side bottlenecks while the increase in fuel prices has resulted from monthly revisions in diesel prices, impacting the transport cost and prices of commodities. Also, the rationalization of subsidy on LPG has had an impact on fuel inflation.
Consequently, CPI inflation, of which food articles form a major portion of the basket, stood above the 10.0% mark. On the other hand, core inflation moderated below the 4% level on account of muted global and domestic demand conditions and sliding global prices.
Overall inflation is expected to moderate in FY14, although countervailing forces from an increase in minimum support price (MSP) shall restrict the decline. Headline WPI is expected to settle in the range of 6.0% – 6.5% (average) and CPI inflation to 8.0% – 9.0% (average) during the year.
Banking activity to revert to a relatively higher trajectory
Recovery in the industrial activities will provide a boost to banking activities; with growth in credit picking up in FY14…
Elevated borrowing costs in the backdrop of high-interest rates coupled with low demand conditions have pressured growth in credit off-take in FY13 to 14.1% when compared with 17% for the corresponding period in FY12.
Growth in credit is generally linked to GDP and to establish the same, a regression analysis has been performed here. The regression of bank credit on GDP aids in gauging growth in bank credit needed to achieve the expected GDP growth of 5.9% – 6.0%. The regression analysis between bank credit, GDP, lagged GDP and interest rate regime shows that only GDP is significant while the interest rate regime and lagged GDP are not. Results from the regression show that for a 6.0% growth in GDP, bank credit needs to grow in the range of 16.5% – 17.0%.
Growth in deposits for the financial year so far has been at 14.3% as against 13.5% last year. There has been a deceleration in growth of demand deposits indicating that corporates are using up their cash balances, against high-interest rate backdrop. A regression of incremental deposits on incremental nominal GDP and incremental domestic savings indicates deposit growth for FY14 to be in the range 14.0% – 15.0% based on these relations. An additional point to look out for this year would be RBI’s monetary policy stance that has primarily been influenced by inflation numbers. The RBI has been following an anti-inflationary policy stance since early 2010.
However, in FY13 RBI reduced key interest rates by 100 bps from 8.5% to 7.5% on growth concerns. With the average inflation expected to decline to 6.5% in FY14, RBI is expected to reduce key interest rates by 50 bps points in the current fiscal as a growth-oriented policy measure. The timing will depend on the movement of inflation as well as the progress on the CAD front which is presently putting pressure on RBI not to lower rates in order to attract foreign capital.
Increased Borrowings to drive Primary Capital Markets
With improvements in growth prospects as well as the continuation of FII flows; investor confidence and investment climate are set to receive a fillip…
Exhibit 4 shows the movement of primary capital markets in India. Equity issuances (IPO, FPO, OFS) have fluctuated against volatile equity markets. Debt issuance, on the other hand, presented a contrasting picture. In the debt segment, while private placements did continue to increase, the public issues were down as seen in Exhibit 4 (b).
Corporates are expected to approach equity markets this year to raise money. Improved sentiments would drive up stock markets yielding better valuations for companies. Union Budget 2013-14 too, expects Rs 55,000 crore of revenue inflows through the disinvestment route which would be contingent on the stock market. Given the higher expected participation limits for FIIs in both corporate and infrastructure debt, as well as the operating of IDFs, the debt market could witness heightened activity this year. But a lot will depend on how the overall economic environment turns out as any big-ticket investment that warrants funding will look at the broader picture. Government expenditure on projects and greater proliferation of PPP projects could provide some impetus here. Also, the timing of interest rate declines would be critical for potential investors in the area of infrastructure. Therefore, heightened activity in this sector may not be expected during the year, although the progress will be gradual.
Stock Markets, however, to remain stable
Recovery in domestic and global macro-economic scenario coupled with relatively stable corporate profitability to boost trading activity against enhanced appetite for risk…
After being subdued in FY12 and for the most part of FY13, stock markets have begun an upward move. The movement of stock markets in FY14 would be influenced by many domestic and global factors. On the domestic front, growth-inflation trends, movement of the exchange rate and current account deficit, policy changes, and political stability in the wake of the 2014 General Elections would be major determinants. These factors would increase volatility in the market. Global developments in the US and Euro-zone could be potential stresses exogenously impacting Indian capital markets.
Despite extraneous risks, Indian equity markets have in the last few years emerged as an attractive investment destination. Indeed, economic and financial problems in developed economies have caused money to flow into countries such as India that have been registering comparatively better growth rates.
Indian markets are widely regarded to be driven by FII inflows. There has been a long-prevailing and strong correlation between FII inflows and stock market movements at 0.83.
In FY13, FII equity gross purchases comprised nearly 26% of the total cash market turnover of the two main exchanges (BSE and NSE) and FII equity gross sales accounted for 22% of total turnover. The trend in the previous years too has been on similar lines. In particular, debt (60% of FII flows) has come to dominate in recent times when compared with equity inflows, which have been volatile due to global uncertainty. Further, with an increase in FII limits in debt (total of US$ 76 bn) and special incentives for investments in infrastructure debt funds, inflows in this space may increase. In all, FII inflows are likely to chart an upward trend in the coming future on expectations of improvement.
Backed by modest economic recovery and FII inflows, the Sensex is expected to remain stable and move between the 18,000 and 20,000 marks in FY14, continuing to be one of the better performing stock markets in the world.
Fiscal matters to be more of pragmatic choices
The Union Budget has targeted a fiscal deficit ratio of 4.8% of GDP for FY14. Given the resolution shown in FY13 in controlling this ratio, it is expected that the FRBM target will adhere to this year too. Consequently, the overall borrowing program for the year which has been placed at Rs 6.3 lakh crore is unlikely to be breached.
There are three concerns, however, relating to the assumptions made by the Budget: the high GDP growth rate of between 6.57.0%, receipts from disinvestment, and spectrum sale. Slippages from these areas would impinge on the ability of the government to maintain the deficit at 4.8%, which will then imply compromising on development (capital) expenditure which is directly under the control of the government.
Hence, while it is expected that the fiscal deficit ratio of 4.8% will not be breached, it could be at the cost of project expenditure, which will have an impact on investment and GDP growth – as both are contingent on affirmative action on the government’s part on both these scores.
External sector developments contingent on global issues
The external sector balance of the economy is dependent on global developments that would in particular be impacted by dynamics relating to economic recovery and fiscal consolidation in the US and Euro-zone economies and resolution of the ongoing Euro debt crisis (including the recently surfaced Cyprus crisis).
FY14 is expected to see a mixed bag of exogenous news, developments, and reactions for the external sector of India, that would also have bearing on the growth potential of the country. In particular, the rate of global recovery as well as the assumption of stable oil prices is critical in this respect.
Trade to pick-up in FY14 and Current Account Deficit to moderate
Backed by a recovery in global growth prospects and revival of consumer demand for imported goods in advanced economies trade would pick-up. Mathematically speaking, trade growth would appear robust and high, primarily driven by low-base effect…
After a high current account deficit (CAD) of 4.2% of GDP in FY12, FY13 for India has been a year of sustained pressure on CAD, which settled at 5.4% in the first nine months. While growth in both imports and exports has moderated, the fall in exports has been far more pronounced (negative growth) when compared with imports (near-zero growth), resulting in a wider CAD. In FY13, CAD is expected to settle in the range of 5.3% – 5.5% of GDP.
Growth in imports will be contingent on the recovery in the economy. While oil imports show a trend growth rate on account of inelastic demand, non-oil imports are based on the recovery within the domestic economy. This component could continue to be under pressure as two components, gold and coal put pressure on the import bill. Low growth in mining would entail higher demand for imports, which in turn can push up the import bill. Exports on the other hand are expected to be dependent more on the state of the world economy. With growth expected to pick up in 2013, though more in the developing countries, a revival may be expected.
As global recovery continues to remain uncertain in the first half of the year, particularly, in the backdrop of the US sequester program (government spending cuts) and a slow US economy, oil prices would be bearish around US$110 per barrel for the year. Gold imports in FY13 have risen, as demand for the precious metal has increased for not just investment but also traditional purposes. Gold prices would remain volatile in both directions depending on the euro-dollar relation as well as physical demand for gold by central banks.
Going forward, we expect exports to grow by 8.0% – 10.0% and imports by 10.0% – 12.0% in FY14. This would result in a mild increase in the trade deficit in absolute terms. In relative terms, however, as a percentage of GDP, the ratio is expected to improve, backed by a higher GDP base.
Simultaneously, the CAD would also improve, supported by greater income flows from software services (US$ 6065
bn in FY14) in the wake of global recovery boosting services imports from India as well as greater transfers/remittances (both personal and corporate, together with expected to be around US$ 65-70 bn in FY14). Imports of POL, gold, and coal on account of increased domestic demand would be a stress factor for CAD. Putting all factors together, CAD in FY14 could settle in the range 4.5% – 4.8% of GDP lower than in FY13, cushioned by a lower trade deficit gap, boost in income from Invisibles, and some price comfort on imported commodities.
Inward capital flows to be robust
Domestic fundamentals in the Indian economy to strengthen; restoring investor confidence and long-term growth prospects along with foreign funds seeking to pocket arbitrage gains…
Despite, the retail and aviation sectors having been opened up to FDI, they are likely to attract very limited new sectoral investment flows. In terms of further policy changes in FDI norms, especially in the pension and insurance segment, we do not expect too much news in FY14. Net FDI could be expected to be between US$ 25-30 bn based on the current dispensation relating to FDI policies. Net FII would be in the range of US$ 25-30 bn which will support the CAD.
Approvals through RBI for external commercial borrowings (ECB) are likely to increase this year, to be in the range of US$ 30-35 bn. With advanced economies maintaining artificially low-interest rates, borrowing costs for domestic firms in raising money abroad would below. Specifically, with the US continuing its asset purchase quantitative easing program, these interest rate differentials would persist.
With economic uncertainty prevailing in advanced economies, emerging market economies led by India would benefit from opportunistic gains of movement of funds away from the former to the latter.
Risks to Rupee depreciation to persist
With demand for dollars remaining high, the rupee is bound to reflect some weakness. Mild comfort is expected to come from improved current account balance and increased capital inflows…
The rupee has depreciated from an annual average rate of Rs 45.9 to a dollar in FY08 to Rs 48.0 to a dollar in FY12. This has further depreciated 5.0%, to Rs 54.4 to a dollar during FY13; also there have been days of considerable depreciation when the exchange rate has crossed even the Rs 57 to a dollar rate during the year. Dynamics in the Euro-Dollar exchange rate would also have a bearing on the movement of the rupee derived thereof.
It may be conjectured that the rupee would move in the range of Rs 53-56 to a dollar during FY14. This could temporarily move towards the Rs 57-58 to a dollar mark, in case of FII outflows in certain months. While a weaker rupee would aid in export growth, imports for India would also become more expensive. In the event of excessive depreciation beyond this range, the RBI is expected to directly intervene in the forex market to curb fall in an exchange rate through dollar purchases. Foreign exchange reserves would register mild net accretion this year.
Authors: Kavita Chacko, Economist: Secondary Capital markets Krithika Subramanian, Associate Economist: Primary and Secondary Capital markets, External Sector (CAD, Capital flows, exchange rate) Anuja Jaripatke Shah, Associate Economist: GDP, Industry, Banking Jyoti Wadhwani, Associate Economist: Agriculture, Inflation, Fiscal position
For further information: Contact: Madan Sabnavis, Chief Economist, 91-022-67543489
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