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Indian Economy: Prognosis FY15

Monday, May 05, 2014

It is expected that the economy in general will improve in FY15, albeit gradually on the premise that a strong government would be in place after the Elections which will reduce uncertainty in business environment and focus on reviving growth. Also based on the prognosis of both the IMF and World Bank, the world economy is to fare better with the impetus coming from the developed economies. However with the IMD bringing out its recent forecast for the South West monsoon being 95% of the long period average, there is some uncertainty on the performance of the farm sector. With 56% forecast probability of the monsoon being below normal, the performance of agricultural sector would be dependent on what finally happens. This is certainly the major downside risk as we move along in the new fiscal year, says CARE Ratings in its annual prognosis on the Indian Economy

The Indian economy has been through challenging times in the last two years, faced with the twin problem of prolonged high inflation and low growth. This was also reflected in lower business sentiments, reduced investments, lowered consumption, compressed revenues, increased government welfare measures and pressure on deficits.

The financial year gone by (FY14) was marred by continued low GDP growth, declining industrial output, decline in investment, higher inflation, lower quality of bank assets, high current account deficit (which has been brought down drastically through affirmative policy action) and depreciation in the domestic exchange rate.

Prospects for FY15
It is expected that the economy in general will improve in FY15, albeit gradually on the premise that a strong government would be in place after the Elections which will reduce uncertainty in business environment and focus on reviving growth. Also based on the prognosis of both the IMF and World Bank, the world economy is to fare better with the impetus coming from the developed economies.

There would also be less global uncertainty with respect to

  • Tapering of quantitative easing measures in the developed world.
  • Political stability - While it is accepted that this assumption would be violated as was with the case of Ukraine recently, it is expected that any such disturbance would be transient in nature.

However with the IMD bringing out its recent forecast for the South West monsoon being 95% of the long period average, there is some uncertainty on the performance of the farm sector. With 56% forecast probability of the monsoon being below normal, the performance of agricultural sector would be dependent on what finally happens. This is certainly the major downside risk as we move along in the new fiscal year.

The weakness in the Indian economy persisted in FY14 with GDP growth as per the advance estimates showing a growth of 4.86%, marginally higher than the 4.5% of FY13. The country has been witness to a sharp drop in its economic growth from an average 8.2% during FY04 - FY12 to sub 5% in FY13 and FY14.

This decline is being attributed to a host of reasons ranging from the low demand, lack of policy actions/reforms, drop in investments, infrastructural deficiencies, delay in project completion on account of procedural delays/bottlenecks, high inflation, high interest rates to general global economic weakness. There is however increasing optimism that the Indian economy could have bottomed out in FY14. Moreover, there is hope riding high that post the general elections in May’14, the new government would initiate growth stimulating measures. This would be a necessary condition for the growth process to revive.

Prospects for FY15:

  • The country’s economy continues to be fragile and the growth in the coming future would be moderate and gradual as the external and internal demand scenario remains weak and is unlikely to see any sudden significant uptick.
  • Even if investments are to pick up, there would be a time lag for infrastructure investments to positively impact the economy.
  • The changes in the Indian political landscape in the coming months, the pace of reforms and policy actions of the new government would define the economic path for the country for the next few years.
    CARE projects a GDP growth of 5.2-5.5% for FY15.

The agricultural sector performed remarkably well during FY14 on the back of good monsoons. As per the advanced estimates, the agricultural sector recorded a growth of 4.6% in FY14 as against the growth of 1.4% in FY13. Food grain production in FY14 is estimated to have touched record levels of 263.20 million tonnes.. The healthy growth of the sector can be credited with propelling the overall growth of the country in the fiscal year gone by.

Prospects for FY15
The IMD has projected a slightly lower than normal monsoon for the year. This by itself should not come in the way of agricultural growth to a significant extent. However, if the el Niño strikes fully resulting in a drought like situation in some parts of the country, there would be further moderation in this growth rate by 100-150 bps i.e. growth of around 0.5-1%.
CARE expects the agriculture sector to grow by 2% under these conditions. Growth will be moderated on account of a high base effect.

The industrial sector has recorded a sharp deceleration in growth from an average 8.6% during FY04 – FY12 to below 1% since FY13. Advanced estimates for FY14 show that the sector’s growth has dropped to 0.65% from 0.96% in FY13. The poor performance of the sector is mainly on account of the negative growth registered in the mining and manufacturing sub-sectors. Overall, depressed investments and a slump in consumer demand have resulted in the low growth in industry. High inflation had negatively impacted consumption demand and investments have declined on account of high interest rates and prevalence of spare capacity.

Prospects for FY15

  • This improvement in industrial sector would be aided by a pickup in the manufacturing sector and recovery in exports as global demand improves gradually.
  • Also, the low base effect of the previous fiscal would aid in improving the overall growth rate for the sector.
  • The infrastructure sector is likely to witness an uptrend and along with manufacturing would lead India’s industrial sector.
    CARE expects a moderate pick up in industrial activity in FY15 with a growth of 2.0%-3.0%.

The services sector has been the single most significant contributor to the Indian economy, accounting for more than 65% of the country’s national income in the last decade. It is also a prominent sector in respect of FDI inflows and employment with average growth of 8.5% during FY3-FY11. Although in terms of share in India’s national income, the sector (including construction) has seen a steady rise since the last decade and half to reach 67% in -FY14, the growth in the sector has been subdued since the last few years – it declined from an average growth rate of 9.7% during FY05-FY12 to 6.2% in FY13 and FY14.
The deceleration in the sector’s growth can be largely attributed to the slowdown in its 2 sub-sectors – (1) trade, hotel, transport & communications and (2) construction. The trade, hotel, transport and communications subsector (which accounts for the largest share in the service sector at 40% saw annual average growth fall from 10.5% in FY05-FY12 to 5% in FY13 and further to 3.5% FY14. Likewise, the construction subsector witnessed growth decline from an annual average rate of 9.8% in FY05-FY12 to 1.4% in FY13 and FY14. The decline in these segments reflects slowdown in the economy. Low industrial growth has impacted the transport sector and less activity in the infra space has affected construction.
The growth in the services sector has been led by the finance, insurance, real estate & business services sub-sector (having a 30% share in the sector) which has witnessed stable growth at around 11%. Community, social & personal services (share of 19%), has grown by an average rate of 6.9% in FY05-FY12 and 6.4% in FY13 and FY14 which may be attributed to government spending.

Prospects for FY15

  • Going forward, growth in the services sector is unlikely to see a significant pickup. The finance, insurance real estate & business services segments would continue to drive this sector.
  • The transport and trade sector could see an improvement if the industrial sector sees an advancement through backward linkages.
    CARE projects an overall growth of 6.75 % for the sector in FY15.

Prolonged high levels of inflation has been a major concern for the general population of the country and policy makers alike and has been driving the country’s policy decisions as well as its consumption demand. Inflation at both the wholesale (WPI) and retail (CPI) level stayed at elevated levels for the major part of the last 3- 4 years. For FY14, WPI averaged 6% and CPI averaged 9.5%.

In FY14, overall inflation was fuelled by high food inflation. Food inflation (WPI) rose by nearly 20% in Nov’13 (y-o-y) with prices of vegetable and fruits soaring to record highs. For the fiscal as a whole, food inflation rose to 13% from 10% in FY13. The fuel & power component of WPI inflation too saw an increase in prices, of an average 10% in FY14, with the deregulation of administered price regime. The manufactured products segment on the other hand witnessed a significant moderation in prices, from an average 5.4% in FY13 to 3% in FY14. In terms of CPI too, food inflation at 11% for FY14 has been the chief contributor to overall inflation.

Prospects for FY15

  • Significant upside risk to inflation in FY15 has emerged on account of the expectation of below normal monsoon. Food inflation is likely to remain in the limelight with increasing worries of the sufficiency of the monsoons this year in the aftermath of the EL-Nino weather conditions.
  • The hike in the minimum support prices (MSP) of agricultural produce too would push up prices of food products.
  • In addition, any unfavourable changes in the global political and economic space and increase in global commodity prices could build into the imported inflation and thereby overall inflation given the excessive reliance of the nation on various imports.
  • Also, a pickup in demand in the developed countries could result in an increase in demand for manufactured goods from emerging economies such as India. This in turn could boost prices of manufactured goods.
    CARE projects for FY15 an average WPI inflation of 5.5% and CPI of 7.5%.

Government Finance
The incumbent Government has delivered in meeting the fiscal deficit target in FY13 at 4.9% of GDP and for FY14 it expects it to be 4.6% of GDP, below the target of 4.8%. It has been achieving this primarily by cutting down on expenditure significantly. In addition to this, the government has been on a drive to increase revenues through dividends from public sector entities and the sale of equity in state owned enterprises in its aggressive attempt to lower the fiscal deficit.

As per the announcements in the Interim budget for FY15, the incumbent Government appears optimistic about increasing receipts by 11.9% and expenditure by 10.9% in FY15. Particularly, while in general receipts will increase, there appears to be a trade-off between the receipts through the recovery of loans[1] and through disinvestment. Further there might be additional support by way of a probable increase in external assistance. On the expenditure side, the new Government is expected to usher in significant capital expenditure in order to bring about a turnaround in growth. This should lead to a rise in revenue and in turn increase aggregate demand in the country which will further encourage growth. Hence, if the economy is not subject to any adverse shock by means of monsoon or any global spill over, receipts will grow, albeit modestly, whereas expenditure will witness significant improvement in FY15.

Judging by how the Government has aggressively met the fiscal deficit targets in the past, it seems likely that the new Government will hope to follow the same route. However, the target for FY15 does appear to be steep at 4.1% of GDP given that there will be a new office in charge facing the major goal of pushing up growth. A revision in the fiscal deficit target can also be anticipated in the announcement of the final budget for FY15. Hence, the final picture will be clear upon the establishment of the new Government.

Monetary Scenario
Credit growth in FY14, as of 21 March’14, was 14.3%, marginally higher than the 14.1% of the comparable period in the previous year. Likewise, deposits grew 14.6% as against the 14.2% growth recorded in FY13. The growth in deposits was largely aided by the over $30 bn FCNR deposit scheme of the RBI in FY13, aimed at boosting the domestic currency from its record lows.

Growth in credit is linked with the state of the economy while that in deposit is related with growth in GDP, inflation, level of interest rates and overall spending.

Prospects for FY15

  • Overall income growth would be higher than that last year, thus allowing space for growth in consumption and savings.
  • Consumption would tend to increase to provide support to industry.
  • Savings will remain stable, but has to come largely from internal sources. There may not be much room for rates to increase during the year as policy rates appear to have peaked. An unfavorable monsoon and higher food prices would be the only reason for further hikes in interest rates. Presently, that may not be expected though is a possibility.

Bank deposits are to grow by 14-14.5% in FY15 while credit growth would be marginally higher at 15-15.5% this year.

With regard to borrowings, net borrowings are to be lower in FY15 at Rs 4.07 lkh crore as against Rs 4.23 lkh crore last year. For the first half of the year, borrowings are to be Rs 3.68 lakh cr. This would not put untoward pressure on liquidity as there would be around Rs 80,000 cr of redemption of Government paper during this period. Therefore, liquidity should be neutral and interest rates stable. The future course of borrowings by the Government is likely to get clearer only post the establishment of the new Government and release of a new Budget. This will also influence the movement in GSec yields. We however do not foresee a significant divergence in the government borrowing programme post elections.

Factors influencing interest rates

  • The repo rate, though the main policy rate has already been scaled down to 0.25% of NDTL for banks.
  • Banks have greater access to the term repo window, which appears to be the way forward for monetary policy too.
  • The RBI has indicated earlier that its objective is to bring CPI inflation to 8% by January 2015, which will serve as a possible trigger.

If the monsoon is normal and inflation under control, the RBI could lower rates in Q4 of FY15 by 50 bps. However, any agri shock which gets reflected in higher food inflation will keep interest rates at the present level, and any untoward overshooting of inflation (which is the extreme case) could warrant a further increase in rates. Therefore, GSec yield for 10-years would range between 8.8-9% guided more by the term repo rate but can settle lower in 8.6-8.8% range if RBI lowers rates towards the end of the year.

External Sector
The external sector’s performance in FY14 has been favourable with exports recording a growth, imports a contraction, the trade deficit moderation and the current account deficit (CAD) a significant decline.

Exports from the country rose to its highest levels of $313 bn in FY14, aided by the depreciation in the domestic currency, low base as well as gradual recovery in trading partners in the developed world. In terms of growth, exports grew by 4.2%, significantly higher than the -2% growth of FY13. The contraction in imports (-8.3%) in FY14 can be solely attributed to the large decline in gold imports following the policy curbs imposed on the same as well as stagnation in non-oil non-gold imports due to negative industrial growth. The decline in imports has greatly contributed to the 28% decline in the country’s trade deficit. The contraction in the trade deficit and the rise in net invisibles have resulted in the decline in the CAD. The CAD for the Apr-Dec’13 period declined to $31.1 billion (2.3 % of GDP) from $69.8 billion (5.2% GDP) in the corresponding period of the previous year. Based on latest media reports, it could be 1.7% for the entire year at around $ 32 bn.

Prospects for FY15

  • There is growing optimism that exports will improve in FY15, with expectations of improvement in global economic prospects and increase in consumption demand in advanced economies viz. the euro zone and the US.
  • The country’s imports too are expected to see an increase, especially the non-oil imports with the resurgence in the domestic economy. Moreover, low growth in mining would entail higher demand for imports and likely relaxations in the import of gold post elections could lead to increase in imports.
  • Trade deficit will be wider than that in FY14.
  • Invisibles inflows would largely be stable and grow at the normal rate.
    CARE Projects exports to grow by 8-9 % and imports by 11-12% in FY15. The CAD in FY15 is projected to be in the range of 2.5-3% of GDP

Foreign Inflows
Despite witnessing turbulence in recent times, India remains one of the top destinations for foreign investments. The growth advantage the country possesses over developed economies remains sizeable and is a key driver for foreign investments, both Foreign Direct Investments (FDI) and Foreign Institutional Investments (FII). The foreign inflows have however been prone to fluctuations.

In terms of FDI, India has seen a steep jump in inflows in the last decade, growing at a compounded annual growth rate (CAGR) of 21%. Nevertheless, the year-on-year FDI inflows have been found to be susceptible to variations. After recording healthy inflows during FY07 – FY09, the subsequent 2 years saw a drop in the same. Likewise, after registering record inflows (34% growth) in FY12, FY13 saw a significant drop of 21%. This moderation in FDI inflows continued in FY14. For the Apr’13-Jan’14 period, FDI inflows into the country have been 7% lower than that for the corresponding period of the previous year.

FII investments too have witnessed a sizeable increase over the years. This segment is however prone to a higher degree of fluctuations (Exhibit 2). In FY14, the country witnessed a sudden and significant (net) outflow of funds, which led to a sharp drop in FII inflows and consequently for the year as a whole the country saw a 66% decline in net FII inflows from that in the previous year. FII inflows into emerging market economies such as India were severely hit in 2013 following the news of the winding down of the monetary stimulus of the US Federal Reserves and the stronger than expected growth in the US economy, which prompted investors to shift their asset holding from emerging economies to the US market.

Prospects for FY15

  • Although, capital inflows into emerging economies is likely to moderate with the tapering of the US stimulus and economic growth gaining momentum, inflows into India is likely to persist.
  • India, despite witnessing a marked slowdown in its economy is widely regarded as a stable economy among emerging markets with untapped potential. The recent surge in FII inflows in the run up to the elections bears testimony to this.
  • A pro-growth government in the centre would further aid the inflow of these funds.
    We expect FDI inflows to increase to around $ 40-45bn in FY15 and FII inflows to be around $15-20 bn.

Forex Reserves
The various measures undertaken by the RBI since September 2013 augured well for the continuation of capital inflows into the country. In addition, the RBI’s swap windows for mobilization of FCNR deposits further aided to build up reserves during FY14. Consequently, forex reserves reached US$304 billion as on 28thMarch 2014, with an accretion of over US$12 billion over March 2013.

Prospects for FY15

  • The current account deficit is expected to widen on the back of an economic recovery.
  • Capital inflows through investment would be higher with a recovery in FII flows.
  • External Commercial Borrowings (ECBs) will continue to be important given the interest rate differential.
    Forex reserves may be expected to move upwards and reach $ 320 by March end.

Exchange Rate
The steep decline in the Indian rupee came to be the foremost economic concern for a large part of FY14. Following a series of policy measures by the RBI and the government, the Rupee strengthened from its record lows (Rs.68/$) and has been fairly stable in recent months at Rs.61-62/$. The stability in the domestic currency is being aided by the improvements in the country’s economic fundamentals viz. the narrowing of the CAD and the increase of foreign inflows into the country.

Prospects for FY15

  • The RBI will play a key role in determining the direction of movement of the rupee.
  • With an announcement to sell bonds under the MSS, there is expectation that the rupee will be held back from appreciating too sharply.
  • Capital flows will largely drive the exchange rate.
    The rupee may be expected to be stable in the range of Rs.60-62/$ in FY15.
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