India Outlook for FY 10
Transcript of India Outlook for FY 10
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India Outlook FY10
Rocky Roadto Recovery
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Index Growth fears to be allayed by policy response and faster global recovery 3
FY09 saw a dramatic turnaround in global and domestic conditions post the Lehman collapse that
shattered the relatively robust working of the economy in the first half. Uncertain global conditions
along with evolving domestic conditions make a point forecast for GDP growth in FY10 virtually
impossible and hence we approach the growth forecasting issue from several alternative dimensions.
Inflation is expected to remain benign 16Reversal in global commodity prices led to swift decline in price pressures since end of last year. We
expect inflation to tread into the negative zone, however the threat of structural deflation remains
distant. Favourable base effect, along with moderate global commodity prices would keep inflation at
benign levels in FY10.
Expansive fiscal policy to continue 18Expansive fiscal policy has become the order of the day, as governments world over try to shore up
economic growth. The initiation of fiscal measures in India since late last year has been prompt,
however they have led to a deterioration of the fiscal parameters. We expect the fiscal deficit to touch
7% in FY10 on account of further increase in plan expenditure.
Softer interest rates to stay 23Changing global and domestic conditions warranted the adoption of an accommodative monetary
policy since September last year. In its fight against the global crisis monetary policy has acted as a
first line of defense for RBI. We expect a softer interest rate regime to continue with a downward bias
on rates.
Though easing of rates have had an expected impact on yields till Q3 FY09, the same is not true sincethen as fears of excess supply of government issuances have dominated sentiment. Considering the
market sentiment towards the problem of excess supply and RBIs response thereof, on an average we
expect the 10Y yield to lie in the range 6.5-7.0% over the next few months. However, in the medium to
long term yields should start reflecting macro fundamentals of benign inflation and moderate growth
when the market recognizes the balance in demand-supply. We expect yields to head towards 6% at
that point.
Near term risks to undermine INR, strength to return on benign BoP outlook 33FY10 is likely to see a more balanced BoP as a narrowing trade deficit helps to improve the current
account and capital account doesnt deteriorate significantly from current levels. In the medium to long
run, Rupee would take cues from the overall benign BoP outlook along with a weakening of the dollar
against the major currencies. In the near term, however, the Rupee will be at depreciated levels as riskappetite remains largely on the sidelines and dollar trades firmly. Further, with event risks lurking in the
near term, the downward pressure on the domestic currency can get exacerbated.
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FY09 The year of two halvesGDP falters after 5 years of plus 8% growth
The year FY09 can actually be called the year of
two halves, where the relatively robust working
of the economy in the first half was shattered by
the impact of the global meltdown post the
Lehman collapse.
In the early part of the year, the ongoing cyclical
moderation was accentuated by rapid tightening
of monetary policy to counter record inflation
levels. This softening up of the economy made
us susceptible to the global shock.
Under the impact of the crisis, growth fell,
liquidity tightened and in response governments
initiated expansive monetary and fiscal policies.Source: CEIC, ICICI Bank Research
IIP Precursor to the deteriorating conditions
Growth of industrial production had started
indicating the slowdown since last fiscal.
The sharp drop in IIP growth in October gave
credence to the worst fears that industrial
production has virtually stalled leading to rapid
build-up of inventories across different industry
segments.
The average growth of IIP declined sharply in
Q3 FY09 to 0.4% compared to 8.4% in Q3 FY08.
The Dec08 and Jan09 figures are also in the
red indicating that the pain has not eased yet. However, there are some nascent signs of
stabilizing in sectors like cement, steel and auto.Source: CSO, ICICI Bank Research
Inflation Does a U-turn As growth momentum started faltering in the
beginning of last year, inflation reared its ugly
head on the back of steep increase in global
metal and fuel prices. Inflation zoomed into the
double-digit zone peaking at near 13% level in
early August09.
Rising inflation was essentially contributed by
increase in manufacturing articles prices (basemetals, edible oil) and fuel prices (increase in
regulated prices of petrol, diesel and LPG).
The peak in inflation was also accompanied with
fiscal and monetary tightening measures, which
led to strained liquidity and high interest rates
thus accelerating the cyclical downfall. Source: Bloomberg, ICICI Bank Research
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FY09 The year of two halvesPolicy rates Switching modes
The monetary tightening measures took the
form of CRR and repo rate being raised by 250
bps and 225 bps respectively to 9% each.
With evolving global conditions, the months of
September October saw a dramatic tightening
of money markets with call rates jumping to
20% levels.
The situation necessitated a change in policy
stance and since then RBI has reduced the CRR
by 400 bps to 5% and repo rate by 350 bps to
5.5%.
Moving in sync with policy rates, the overnight
call rate and bond yields eased significantly
from the stressed levels of October.Source: Bloomberg, ICICI Bank Research
Virtual paralysis in the external sector The downward growth momentum and falling
external demand in the face of global recession
has started to reflect in the external trade data.
Export growth has remained in the negative for
the fifth consecutive month.
Export growth averaged 22.7% in H1 FY09 while
it has averaged 12.2% between Oct08-Feb09.
Average import growth has fallen to 3.2%
between Oct-Feb09 from 38.7% in H1 FY09.
The trade deficit, which had ballooned in the
earlier part of the year, has started to ease on
account of falling imports.
Source: CSO, ICICI Bank ResearchAnalysing the growth outlook for FY10 A conceptual framework
Uncertainties about the prognosis of global recovery and inability to fathom the dent in sentiments would
make a point forecast for GDP growth in FY10 virtually impossible and hence we approach the growth
forecasting issue from several alternative dimensions.
Our broad thought is to look at GDP growth from both demand side and supply side as well as from the
perspective of how the long-term structural factors would play out. We start off with an analysis of the
savings-investment trends and try to arrive at growth estimates through the productivity of these
investments, as reflected in ICOR.
The demand side approach concentrates on the drivers of consumption and investment demand. Weidentify the possible trends in consumption that could emerge in FY10 and also discuss how the quantum
of investment would be conditioned by both business sentiment and availability of finance. In supply side
analysis we focus on the outlook for agriculture, industry and services. All through our analysis, we are
aware that the outlook for FY10 would have to be conditioned for extreme volatility. So simultaneously we
undertake a historical exercise of trying to gauge how much different components of GDP respond in
slowdown years. These approaches lead us to construct 3 possible scenarios for growth in FY10.
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CRR Repo rate(%)
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Exports growth (3m MA) Trade balance (RHS) (USD bn)(% YoY)
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Savings & Investment structural determinantsParadigm shift in savings propelled growth Savings and Investment are the traditional
structural determinants of growth; more so in a
developing economic set up.
The structural shift of the economy is visible
with average savings rate rising to 33.6% in the
last five years from 24% in the prior five year.
While household savings account for almost
70% of gross domestic savings, its share has
fallen from close to 90% in 1990s.
The share of private corporate savings has
increased markedly from close to 14% in FY02
to 23% in FY07. Of equal importance is the fact
that public sector has turned into a net saver
from being a net dissaver in FY03.Source: CSO, ICICI Bank Research
...and led the upsurge in investment The shift in trajectory of Indias growth path has
been a result of the turnaround in investment
growth from negative and single digit levels.
In a scenario of rising domestic savings,
availability of capital is easier which fuels
investment demand.
The financing of investment shows that
domestic savings accounts for roughly 96-99%
of total investment indicating that the reliance
on external sources of financing is minimal.
The trend in investment growth shows its erratic
nature before FY03 but since then the stability in
investment growth has been remarkable.Source: CSO, ICICI Bank Research
The data suggest that a slowdown year impacts private and public sector savings while household
savings remain stable. With sluggish growth expected in FY09 and FY10 private corporate sector
savings as a proportion of GDP would fall - historically, the fall has been less than 1%. However, in
FY09 and FY10 the fall could be higher since the ratios are at elevated levels initially.
With falling corporate and public savings we expect gross domestic savings as a percentage of GDP to
fall to near 32% levels in FY10 from the high of 37.7% in FY08.
HH savings
to GDP (%)
Change from
previous year
Pvt corporate
savings to GDP
(% )
Chan ge from
previous
year
Pub lic sector
savings to
GDP (%)
Chan ge from
previous year
GDCF to
GDP (%)
Change from
previous year
FY 95 20.5 1.4 3.8 0.0 2.6 1.2 25.5 3.0
FY 98 19.4 1.7 4.7 -0.3 2.0 -0.4 25.3 1.3
FY 01 23.6 0.5 4.2 -0.7 -1.9 -1.0 24.3 -1.6
FY 03 25.2 1.1 4.2 0.5 -0 .7 1.5 25.2 2.4
FY 07 26.1 -0.3 8.5 0.4 3.5 0.7 35.9 0.4
H ou se h o ld S av in g s P r iv at e C o rp o r a te sa vin g s P u b lic se c to r s a vin g s C a pit a l f o rm a tio n
Benchmark years Slowdown years
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11Savings as a % of GDP Real GDP growth (RHS)
Real GDP growth between 7.5-
9.4% when savings between 30-
35% of GDP
Real GDP growth between 4-6% when
savings ranged between 22-23% of GDP
(%) (%)
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11Investment growth Savings growth Real GDP growth (RHS)(%) (%)
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Productivity gains catalyze investment into growthProductivity of investment dips in slowdown The impact of investments on overall GDP
growth is conditioned by the productivity of
those investments.
Productivity gains on the back of technological
progress and entrepreneurial innovations have
been reflected in the incremental capital output
ratio (ICOR - a measure of how much capital is
needed to produce an additional unit of output).
Between 2000-06 Indias ICOR averaged 4,
lower than that of China at 4.3 and Brazil at 5.1.
ICOR has tendency to rise in a slowdown year.
During the slowdown of FY03 ICOR jumped to
6.9 from 4.5 in the previous year. ICOR for FY09
based on advanced estimates is at 5.3 from 4.2
in FY08. Source: RBI, ICICI Bank ResearchEfficiency loss to be offset by investment We have tried to simulate the implied
investment growth for a given level of GDP
growth and ICOR for FY10.
The table on the right shows, the assumed GDP
growth for FY10 and the ICOR levels expected
to prevail in FY10, different combinations of
which yield an implied investment growth.
Analysis for FY10 shows that for the GDP to
grow by 6.5% and with assumed ICOR at 6,
investment would have to grow by 12%. Withinvestment growth already moderating to near
8.5% levels in FY09 such a scenario in FY10
seems fraught with difficulties. Implied investment rateSource: ICICI Bank Research
Safe-haven component may pose a challenge Flight to quality a natural response of the
household investor in bad times leading to a
rise in the safe haven components
Changes in household assets shows that
slowdown years are marked by a rise in
deposits and LIC funds indicating the risk
averse nature of households. We expect the share of financial savings in total
savings to decline, as households would turn
averse to risky assets. This could potentially
thwart the productivity of investable funds.
During previous slowdown years share of
financial savings in total savings has dropped
between 5-7% while that of physical savings has
increased by a similar amount.Source: RBI, ICICI Bank Research
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Proportion in change HH assetsDeposits Currency LIC PPF Shares & Debentures Others
(%)
During slowdown years proportion of LIC & deposits rises
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ICOR rises sharply during slowdown years
ICOR GDP (RHS) (% YoY)
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5.5 -21 -13 -6
6 -14 -5.5 36.5 -7 2.3 127 0 10.2 20
GDP
Growth in
FY10
ICOR levels
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Demand side developments in past slowdownsConsumption growth falters in slowdown Moving on from the savings investment
approach we look at the consumption investment angle in the demand side of the
growth dynamics.
The chart on the right shows the scatter plot of
consumption growth in the year t vis--vis the
previous year t-1. The points on above the 45
degree line represent a slowdown in year t vis-
-vis in year t-1.
The highlighted points indicate consumption
growth in a slowdown year vis--vis the
previous year. This analysis reveals that private
consumption growth could fall by 3 - 5% points
from the previous year and could make a
significant difference to the forecast for FY10. *Highlighted years are slowdown years FY98, FY01, FY03Source: CEIC, ICICI Bank ResearchInvestment growth follows a volatile trend The share of investment rose from 23% of GDP
in FY03 to 32% in FY08. Improving corporate
balance sheets was a big contributor to this.
The chart on the right shows the scatter plot of
investment growth in the present year t vis--vis
the previous year t-1. Absence of a particular
pattern corroborates with the erratic nature of
investment growth.
It is interesting to note that in 2 out of 3 cases
poor investment growth actually preceded aslowdown year rather than following it. Theimplications for FY10 would depend on how
deeply entrenched is the investment
deceleration.
*Highlighted years are slowdown year FY98, FY01, FY03
Source: CEIC, ICICI Bank ResearchGDP growth deviates from its upward trend The chart on the right shows the scatter plot of
GDP growth in the year t vis--vis the previous
year t-1. The points above the 45 degree line
represent a slowdown in year t vis-a-vis in year
t-1.
With most of the points falling to the right of the
45 degree line, we see that growth has been onan uptrend.
In a slowdown year as expected GDP growth
drops sharply compared to the previous year,. A
similar pattern for consumption growth seems
to indicate that the projection of GDP growth for
FY10 would depend critically on how
consumption responds. *Highlighted years are slowdown years FY98, FY01, FY03Source: CEIC, ICICI Bank Research
Y(t) = 0.2208Y(t-1) + 3.8163
R2
= 0.0581
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Private Consumption growth (t)
Private
Consum
ption
grow
th
(t-1)
Y(t) = -0.0651Y(t-1) + 10.103
R2= 0.0042
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Investment growth (t)
Investm
entgrow
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GDP growth (t)
GDP
grow
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Criticality of consumption to the overall growthThe story of consumption evolution Consumption accounts for 70% of GDP and its
significant expansion has been promoted by the
emerging middle class and ably supported by a
transformation in rural India.
The chart here shows the stable and rising
consumption growth. The quarters of a fall in
growth are largely associated with a bad
monsoon.
The 15 consecutive quarters of more than 5%
consumption growth has not been at the
expense of domestic savings, but primarily
because of the rising disposable incomes.
Maintaining a healthy consumption growth will
be critical for overall GDP growth in FY10. Source: CEIC, ICICI Bank ResearchConsumption Sustainers Rural demand to remain resilient (~57%
workforce in agriculture). Agriculture &
government services remain unaffected and to
benefit from govt measures. State pay
commission to infuse purchasing power
Faster rising affordability on the back of falling
prices
Lower interest rates to boost consumption
Favorable wealth effect a surge in income
levels over the past years to provide a cushion
during this period of slowdown
Long term structural factors intact -
demographic advantage, rising middle class and
fast rising skilled labour
Potential pitfalls in consumption growth Falling industrial output and uncertain global
environment to reduce employment
opportunities in near term
Lagged effect of downturn on services could
feed into employment uncertainty
On the back of uncertain job climate and falling
availability of credit consumers might be forced
to defer discretionary purchases
With a sharp reversal in equity and real estate
markets, more and more consumers would feel
the pinch and this erosion of wealth could havean adverse impact on a particular segment
Global risk aversion to weigh down on
consumer sentimentPay Commission impact to linger on Governments measures centre & state pay
commission, employment programs would
help to mitigate pressure on consumption.
The table shows that there was a staggered
impact of the 5th pay commission on the wage
expenses for the centre and the state lasting till
FY01. Wages and salaries of the centre as a %of GDP rose from 2.7% to 3.3% while that of the
state rose to a high of 7.2% on account of the
5th pay commission.
Thus taking into account a similar rise of the
wage bill for the centre and state, the 6th pay
commission would give an income boost of
upto 1.4% of GDP. Source: RBI, ICICI Bank Research
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Private Consumption growth(% YoY)
Central Government
INR bn % to GDP INR bn % to GDP
1996-97 371 2.7 912 6.7
1997-98 500 3.3 996 6.5
1998-99 572 3.3 1156 6.6
1999-00 648 3.3 1357 7
2000-01 661 3.1 1508 7.2
2001-02 640 2.8 1525 6.7
2002-03 706 2.9 1588 6.5
2003-04 735 2.7 1847 6.7
2004-05 808 2.6 1847 5.9
2005-06 906 2.5 2069 5.8
2006-07 941 2.3 2131 5.1
2007-08 1005 2.1 2259 4.8
2008-09 1357 2.5 2700 4.9
2009-10^ 1561 2.6 3300 5.5
^ : Assuming similar impact as of 5th Pay commission and nominal
GDP growth of 10%
Note - Data for state govt post 2005-06 is calculated assuming similar
growth as for central govt over the subsequent years
Wages, salaries and pension
* :Non-plan revenue expenditure of the States going to social,economic and administrative services
State Governments
(Consolidated)*
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Lower prices and rates to provide further reliefHow much will falling prices matter?
As mentioned earlier affordability could outpace
the fall in income
Inflation as measured by WPI has convincingly
reversed its tract after growing at double digits
last year. We expect negative inflation to prop
up this year for a few months, before prices
start rising again.
However, falling inflation could also have anadverse impact wherein consumers would defer
purchases in anticipation of further fall in prices.
The current fall in prices is a phenomenon
driven by the statistical base effect, and hence
this is expected to wane at the latter part of the
year, diluting its impact on consumer behavior. Source: Bloomberg, ICICI Bank ResearchAuto sales correlate well with WPI trends To substantiate the above point we analysed the
trend of auto sales growth with the headline
inflation figure.
The graph shows clearly that an inverse relation
exists between falling prices and auto sales
growth and the correlation between auto sales
and WPI lagged by 3 months is close to 0.5.
Auto sales is a component of leveraged
spending by the consumers. Hence we feel that
the impact of falling prices on auto sales could
be coming through the interest rate channel -phases of falling prices are also associated with
easing interest rates.Source: Bloomberg, ICICI Bank Research
Falling rate could support leveraged spending Private consumption, has an inverse
relationship with interest rates adjusted for
inflation.
However the relationship works with a lag. As
per economic logic, lower rates help to
stimulate demand as cost of credit reduces and
this is reflected in the high correlation of 0.7.
We have used the 1-year prime lending rateadjusted for inflation for the purpose of analysis.
The relationship is sensitive to the use of the
PLR and it weakens significantly on taking the 1-
year deposit rate (correlation falls to 0.4).
With PLR rates expected to fall in FY10, we
could see a potential upside for consumption. Source: RBI, ICICI Bank Research
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Inflation
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Auto Sales 3 Month MA
WPI lagged by 3 months (inverted, RHS)
(% YoY) (% YoY)
Falling inflation to prop up auto sales
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Investment and exports could be a drag on growthFalling rates to shore up investment From the demand side, analysing investment
demand will be complementary to the analysis
that we have done for consumption demand.
We analyze the impact of lower rates on
investment and it indeed does have a positive
relation. Lower rates reduces cost of funds
relative to potential returns and this helps
encourage more investment. Lower rates would
also help to make some projects more viable.
In case of consumption the mechanism works
through a lag, for investment though counter
intuitive the relation holds in the immediate
period. However, a depressed business
sentiment could delay this impact. Source: CEIC, ICICI Bank Researchbut financing could be an area of concern In the recent past the proportion of foreign
flows helping finance investment had increased
markedly.
The freezing of global financial markets post the
Lehman collapse led to ripple effects in India
adversely affecting the foreign flow of funds.
In an environment where investment grows, its
financing would increasingly depend on bank
credit. However with the proportion of bank
credit to total financing rising to 60%, its
sustainability remains questionable in the future. Other sources of foreign flows such as FDI
which have seen a spurt in FY09 might not be
forthcoming in FY10 thus worsening the outlook
for FY10. Source: RBI, ICICI Bank ResearchExternal sector to shave off GDP growth
The share of external sector (exports and
imports) has risen from 17% in 1991 to 36%
recently. With imports been much higher than
exports, net exports usually has been a negative
contributor towards GDP growth
Looking at the trend of contribution of net
exports to GDP growth since FY01, we see thatit could shave off between 0.5-3.5% points from
the overall GDP growth.
With a high probability of stagnating exports
being counteracted by declining imports,
negative contribution of net export to GDP
growth would be muted in FY10.Source: CEIC, ICICI Bank Research
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Contribution of Net exports to GDP growth
GDP growth
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25Correlation of -0.8(%) Real interest rate Investment (RHS) (% YoY)
FY08* FY09*FY08*INR bn
FY09* INRbn
A) Bank credit to the industry 45 60 2249 2932B) Flow from non banks 55 40 1509 980B.1. Domesstic Sources 25 19 1259 9331. Public issues 7 3 344 136
2. Gross pvt placements 6 8 323 391
3. CP's subscribed by non banks 6 4 314 200
4.Others 6 4 278 207
B.2. Foreign Sources 30 20 1487 9811. ECB/FCCB 13 6 630 276
2. ADR/GDR 5 1 250 47
3. Short term credit 8 3 416 1234. FDI to India 4 11 191 536
Toral Credit (A + B) 100 100 4995 4847* as reported by RBI in the Macro & Monetary Development Jan'09
Sources of financing as % o f total credit to industry
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8/14/2019 India Outlook for FY 10
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Analyzing past slowdowns from the supply sideWide variations in agriculture growth
Moving on from the demand side analysis of
GDP to the supply side analysis, we try toinvestigate the probable paths of agriculture,
industry and services growth in FY10.
Agriculture growth suffers from sharp volatility
owning to exogenous factors. A scatter plot is
used to depict agriculture growth in year t vis--
vis the previous year t-1. Points above the 45
degree line represent slowdown in year t
compared to year t-1. The negative slope of the
regression line could indicate severe base
effects. Poor agriculture growth generally
accentuates the slowdown but is generally not
caused by an industrial slowdown. *Highlighted years are slowdown years FY98, FY01, FY03Source: CEIC, ICICI Bank ResearchIndustrial growth may be affecting with a lag The graph on the right shows industrial growth
in year t vis-a-vis in year t-1. The upward
sloping regression line indicates that a good
production year is followed by a better one.
Points above the 45-degree line represent
slowdown in year t compared to year t-1.
However not in all slowdown years, do we see a
moderation in industrial growth. Probably
slower industrial growth in one particular year
impacts other segments of the supply side with
a lag and GDP growth contracts with a lag.
With a sharp drop in industrial growth in FY09, it
is possible to have a somewhat better industrial
growth number in FY10. *Highlighted years are slowdown years FY98, FY01, FY03Source: CEIC, ICICI Bank Research
Message from past industrial growth cycles We looked at the movement of IIP growth in the
slowdown phase of FY01 and FY98.
IIP growth fell for 14 months prior to reaching
the trough during the slowdowns of FY98 and
FY03. While in the case of FY01 we see
sideways movement of IIP growth for upto 10
months after reaching the trough, in case of
FY98, IIP growth shows some semblance ofrecovery in the subsequent months.
In the current phase too IIP has been in a
downtrend for a similar time, but we would
have to wait to conclude if the trough has been
hit. The pace of recovery in FY10 would depend
on inventory adjustment, global factors and
business sentiment, among other things.Source: CSO, ICICI Bank Research
Y(t) = -0.7346Y(t-1) + 5.2377
R2
= 0.5435
-10
-8
-6
-4
-2
0
2
4
68
10
12
-8 -6 -4 - 2 0 2 4 6 8 10
12
Agriculture growth (t)
Agriculture
grow
th
(t-1)
Y(t) = 0.4957Y(t-1) + 3.2765
R2
= 0.2488
0
2
4
6
8
10
12
0 2 4 6 810
12
Industry growth (t)
Industry
grow
th
(t-1
)
-2
0
2
4
6
8
10
12
14
t-1
t-3
t-5
t-7
t-9
t-11
t-13 t
t+
2
t+
4
t+
6
t+
8
t+
10
IIP
Slowdown of FY98 Slowdown of FY01 Current Slowdown
(% YoY)
t - month of lowest growth
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8/14/2019 India Outlook for FY 10
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Will service sector be able to hold on?Service sector has defied growth cycles The chart here shows a scatter plot
representation of service sector growth in year tvis--vis that in year t-1. Points above the 45
degree line represent slowdown in year t
comapred to year t-1.
In a slowdown phase, the drop in service sector
growth in one year has not been rapid except in
one instance. However that occurred in the time
of the tech bubble burst and therefore
understandable.
Extending this logic further, FY10 service sector
growth seems to be less at risk, but the extent
of global meltdown would pose significant
challenges.*Highlighted years are slowdown years FY98, FY01, FY03
Source: CEIC, ICICI Bank ResearchGovernment expenditure to aid recovery We looked at the community, social and
personal services segment, which essentially
reflects the government revenue expenditure
and has a correlation of close to 80% with the
same. Q3 growth of 17.3% YoY reflects the
same.
The chart clearly shows that while its share in
GDP is at a modest 13-14%, its contribution to
GDP doubled in Q3 FY09 to 2.05% from 1.08%
in Q2 FY09.
Going forward this sector could hold the key fora robust service sector growth as stress on
fiscal stimulus remains.Source: CEIC, ICICI Bank Research
Trade, hotel and transport could be at risk Trade, hotels and transport segment of services
has not only gained importance in terms of
share in GDP but its contribution to GDP has
also witnessed marked improvement. Its
contribution to GDP rose from 1.5% in 1997 to
3% in 2007 before falling to 1.8% in Q3 FY09.
However the heterogeneity of this sector could
pose a problem in terms of analyzing its future
growth path. While poor global conditions and
heightened security concerns post the terror
attacks could adversely affect the trade and
hotels segment, domestic demand for
communication services still remains strong.Source: CSO, ICICI Bank Research
Y(t) = 0.5788Y(t-1) + 3.0906
R2
= 0.3372
3
4
5
6
7
8
9
10
11
12
3 4 5 6 7 8 910
11
12
Services growth (t)
Servicesgrow
th
(t-1
)
-1
-0.5
0
0.5
1
1.5
2
2.5
3
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
6
9
12
15
18
21Community, Social & Personal Services
Contribution to GDP growth Share in GDP (RHS)
(%)(% YoY)
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
Dec-98
Dec-99
Dec-00
Dec-01
Dec-02
Dec-03
Dec-04
Dec-05
Dec-06
Dec-07
Dec-08
18
21
24
27
30Trade, Hotels and Communications
Contribution to GDP growth Share in GDP (RHS)
(%)(% YoY)
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8/14/2019 India Outlook for FY 10
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How vulnerable is India to the global crisis?The vulnerability indicators
Source: McKinsey, CEIC, ICICI Bank Research
Having discussed the sectoral composition ofthe GDP, it would be useful to see this in the
context of vulnerability of the sectors.
We have defined sectors with maximum
domestic linkages and easy supply of credit as
the least affected sectors as the risk stemming
from a global downturn is minimal. Sectors that
have greater exposure to external sector and
face credit constraints along with an overhang
of supply are deemed worst affected.
The moderately affected sectors are the ones
facing demand constraints, however cred
availability remains strained.
It is interesting to note that while the worst
affected sectors account for 42% of the GDP,
they contributed roughly 55% of the GDPgrowth in FY08.
* The vulnerability classification is by McKinsey
Vulnerability risk to the global crisis stand evenly balanced for India
Source: IIF, Ecowin, ICICI Bank Research
Based on a host of parameters different countries have been ranked according to their vulnerability to the
global crisis with the rank 1 given to the least vulnerable country. Countries are then judged as highly
vulnerable or least vulnerable using the average score of the ranks for different parameters.
Such an exercise has yielded the result that vulnerability risk to a global crisis is evenly balanced for India
compared to its peer group.
Worst affected
sectors - 42%
Least affected sectors -
30%
Moderately affected
sectors - 29%
Share in GDP
Worst affected
sectors - 55%
Least affected sectors -
20%
Moderately affected
sectors - 25%
Proportion of Contribution to GDP growth in FY08
Agriculture, Forestry & logging, Fishing, Public
administration & defence services, Other
services
Mining & Quarrying, Registered ,Trade, Hotels &
Restaurants, Banking & insurance, Business
Services
Railways, Transport by other means, Storage,
Communications, Unregistered Manufacturing
Region
External
debt
Forex
reserves
Short term
debt
Short
term debt
Equity
markets
Domestic
credit
Fiscal
deficit
Current
Account
Balance
Average
score
(% GDP) (% debt) (% reserves)
(% total
debt)
(% change
since Jan'08) (% GDP) (% GDP) (% GDP)
China 2 1 1 12 10 11 4 2 5.4
Indonesia 4 8 7 3 7 2 6 6 5.4
Brazil 1 11 4 4 2 6 7 8 5.4
India 6 4 2 5 8 5 8 9 5.9
Russia 8 5 6 6 12 4 12 3 7.0
South Korea 10 6 10 11 3 10 3 7 7.5
S Africa 5 7 9 8 1 12 11 12 8.1
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8/14/2019 India Outlook for FY 10
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Looking ahead to FY10
Source: CEIC, ICICI Bank Research
Having analysed growth dynamics through different appraoches, we now try to construct probable
scenarios that could emerge in FY10.
The trends of the GDP components show that consumption has had a more stable past than the widely
fluctuating investment. However the India growth story with plus 8% growth over the last five years,
has been fuelled by a surge in investment growth led by healthier corporate balance sheets, capacity
expansions and enhanced productivity.
While during a slowdown average rate of consumption growth has slipped only by 1-1.2%, investment
growth falls by a greater amount of about 4% compared to the long term average.
Consumption growth has a tendency to dip in years with a bad monsoon and the lowest consumption
growth of 2.6% too occurred in a drought year.
With lack of fiscal room available in previous years, we see that average government consumption
growth during slowdown years is only marginally higher compared to the long term average. Howeverthere is reason to believe that the trend would not hold in the current slowdown phase with the
government boosting the economy through doses of higher expenditure.
Challenging times ahead
While growth in FY09 is expected to fall below
the 7% level, the challenges seem to multiply in
FY10.
With a dismal global backdrop and poor
domestic conditions the FY10 seems to be a lot
more difficult year than FY09.
For GDP growth in FY10 to reach near 6-6.5%
levels, consumption would have to grow by 5-7% and investment would have to grow by 7-
10%. This would be plausible if the government
measures to boost consumption growth seep
into the system rapidly and early signs of pick-
up in demand encourage capacity expansion
plans. Source: CEIC, ICICI Bank Research
24
710
12
3
5
70
2
4
6
8
Consumption
(% YoY)
GDP
(% YoY)
Investment (% YoY)
Scenarios for FY10 GDP
All possible scenarios
Growth rates (%) GDP
Private
consumption
Govt
consumption Investment Exports Imports
Avg growth in last 13
years 6.93 5.81 5.51 10.21 14.37 15.51
Avg growth last 5
years 8.92 7.01 4.76 15.76 15.03 22.12vg growt ur ng
slowdown 5.11 4.60 6.59 6.44 12.55 9.71
Minimum 3.77 2.67 -0.35 -4.10 -2.33 -2.44
Maximum 9.69 8.67 13.23 21.99 31.40 45.58
FY08 9.00 8.30 6.90 13.80 7.50 7.60FYTD 6.80 6.50 13.20 10.00 15.50 25.30
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8/14/2019 India Outlook for FY 10
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Constructing growth scenarios for FY10The bareminimum
Global headwinds: Export growth
contraction continues
for most part of FY10
Outflow of foreign
funds on worsening
global condition and
rating downgrade
Domesticconditions: Corporate savings
led collapse in gross
domestic savings
Cost and availability
of credit continue to
remain a sore point
for consumers and
corporates
Tight consumer
lending, employment
uncertainty and
adverse wealth effect
to weigh on private
consumption Inventory build-up
stalled by uncertain
consumption outlook
Investment projects
shelved with no
intention of adding
new projects
Financial instability
due to global
developments
Depressed asset
prices keep business
and consumersentiment down
Political uncertainty
worsens post
elections
Signs ofrecovery,domesticfundamentalssupport
Propelled bypolicy pushGlobal headwinds Export growth
falters but manages
positive growth of 2%
Some FDI inflows
but FIIs and ECB
lenders remain on the
sidelines
Domesticconditions: GDS does not drop
below 32% of GDP
Gap in investment
financing partially
bridged by
government initiatives
and partly by RBIs
liquidity providing
measures
Discretionary
purchases deferred,
rural spending helps
maintain growth of
consumption around6%
Inventory
drawdown in H1
paves way for a build-
up later
Investment pipeline
to be completed as
per schedule but fresh
proposals would not
be forthcoming
Sentiment improves
in H2 FY10 on the
back of globaldevelopments
Election results
throw up at least a
stable government
Aided by globalrecovery
Global headwinds: Global economy
sees some recovery
by 2009 end
FDI continues, FIIs
search for relative
valuation and some
appetite for ECBs
revive
Export growth
recovers in H2 FY10
Domesticconditions: Bank credit flows
helps to revive
investment
investment growth
does not drop below
7%
The recovery
process is swift with
the crisis not
spreading to other
sectors Retail credit
resumes providing
impetus to
consumption
Business and
consumer sentiment
recovers quickly
Inventory
adjustment is promp
and this fuels capacit
expansion and fresh
projects
Election resultsthrow no surprises
and new govt
committed towards
further reforms
Shorterglobalrecession,proactivepolicy action
GDP growthof 5.5 - 6% GDP growthof 6 - 6.5% GDP growthof 7 7.5%
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8/14/2019 India Outlook for FY 10
16/45
Inflation Diverging trendsMoney Supply Inflation link breaks down Historically money supply growth and inflation
have depicted positive correlation of 0.65%.
While inflation peaked at near 13% levels in
Aug08, money supply growth dipped at that
time from 22% levels in the previous months to
around 20% levels. Correlation of money supply
and inflation turned inverse in the period of
Jan07 and Feb09.
Our forecast of negative inflation in the first few
months of FY10 confirms that this inverse
correlation will continue. However, any rapid
monetary growth to finance fiscal deficit would
have potential long-term inflationary bias.Source: Bloomberg, ICICI Bank Research
CPI and WPI paint different inflation scenario With the rise in WPI last year, the consumer
price index also rose, however the drop in the
WPI off late has not been mirrored by the CPI.
While WPI averaged 3.2% in Feb09, the CPI
reading for Feb09 was at 9.63%. It is expected
that CPI would fall, however only with a lag.
The differing weights for food, fuel and metals
between CPI and WPI are the main reason for
this divergence. While food prices have been
moving up and account for 47-57% of CPI fuel
prices, which are falling account for only 3-7%
of CPI.
Source: CEIC, ICICI Bank ResearchPrimary articles inflation still elevated
While headline inflation figure has been edging
down rapidly since Oct last year, driven by fall
in fuel and manufacturing good prices, the
primary articles inflation has not eased as much.
The high MSPs set by the government for rice,
wheat, urad and tur have been precluding the
fall in food prices.
Higher prices of food articles also have anindirect impact on WPI through higher prices of
manufactured items. The sensitivity of policymaking to primary article
prices would deter any strong reaction to
negative headline inflation numbers.Source: Bloomberg, ICICI Bank Research
10
15
20
25
30
35
40
45
M
ar-91
M
ar-92
M
ar-93
M
ar-94
M
ar-95
M
ar-96
M
ar-97
M
ar-98
M
ar-99
M
ar-00
M
ar-01
M
ar-02
M
ar-03
M
ar-04
M
ar-05
M
ar-06
M
ar-07
M
ar-08
M
ar-09
0
2
4
6
8
10
12
14
16
18M3 Inflation (RHS)(% YoY) (% YoY)
Correlation of 0.65
0
2
4
6
8
10
12
Feb-07
Apr-07
Jun-07
Aug-07
Oct-07
Dec-07
Feb-08
Apr-08
Jun-08
Aug-08
Oct-08
Dec-08
Feb-09
0
2
4
6
8
10
12
14
CPI WPI (RHS)(% YoY) (% YoY)
0
2
4
6
8
10
12
14
Apr-0
8
M
ay-0
8
Jun-0
8
Jul-08
Aug-0
8
Sep-0
8
Oct-08
Nov-0
8
Dec-0
8
Jan-0
9
Feb-0
9
M
ar-0
9
Whole Index Primary Index(% YoY)
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8/14/2019 India Outlook for FY 10
17/45
Structural deflation is not a serious threatRecessions need not always be deflationary Historically, the notion of deflation has been
associated with periods of recession due to the
Great Depression experience.
To analyse the same we empirically study the
relationship between inflation rates and GDP
growth of 22 countries over the period 1960-
2005.
Our results point to no clear link between
inflation and GDP growth. While we found 31
cases where low inflation occurred with periods
of positive GDP growth, 22 cases of high
inflation occurred in periods of recession.Source: World Bank, IFS, ICICI Bank Research
Indias vulnerability to deflation relatively low
An index of Deflation Vulnerability constructed
by IMF shows that the deflationary risks have
increased in the global economy, particularly in
the G 7 countries. Higher the value of the index,
the more the deflationary pressures.
Japan is the only country, which has very high
risks while 13 other countries (out of 35) display
moderate risk of deflation. For India, the index
suggests minimal deflationary risk.
The deflationary risks for the global economy as
a whole (GDP weighted) has increased to 0.34 in
2009 from 0.32 in 2003. This rise in risks is
primarily driven by negative output gaps and
low asset prices. Source: IMF, ICICI Bank ResearchInflation expected to average close to 2-3% On the basis of a simple statistical exercise
assuming primary, manufacturing and fuel
indices to closely mirror the trend in the past
five years, we have tried to forecast the weekly
inflation figures for FY10.
As per our analysis inflation would enter the
negative zone over the next few weeks and
remain in the red for most part of 2009. This fallin the year on year inflation is essentially on
account of the base effect.
Our forecast chart of the inflation figures for
FY10 is a statistical exercise to reflect the base
effect. However going forward as commodity
prices pick up from the abysmally low levels, we
expect inflation to average about 3% in FY10. Source: Bloomberg, ICICI Bank Research
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8/14/2019 India Outlook for FY 10
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Overview and comparison of fiscal deficitIndia fares poorly in comparison
Expansion of fiscal deficit has become a global
theme as governments across the world are
trying to cushion the falling economic growth.
Among the developed countries, US, UK, and
Japan are expected to record extremely high
deficit numbers over the next two years as
governments in these countries provide
stimulus in a phased manner. Russia has
slipped from surplus to deficit mode rapidly. Indias performance on the fiscal parameter has
deteriorated because of stimulus measures,
populist expenditure, and high commodity
prices in the recent past.Source: IMF, ICICI Bank Research
Combined fiscal deficit looks onerous
The combined fiscal deficit of the government is
budgeted to be close to 8.5% of GDP in FY10.
However, we expect centers deficit to touch 7%
due to 1% increase in plan expenditure and
approx. INR 300 bn of tax cuts announced post
the interim budget. Considering about 1%
stimulus by the new government in FY10, the
deficit could touch 8%. These correspond to
two likely scenarios A and B, for the FY10 deficit
(for details see the bond market section). Hence
the combined deficit could lie between 10.5-
11.5% under the two different scenarios
considered above.
Off-balance sheet items, which are expected to
be less in FY10, could potentially add another
0.7% (compared to the 2.4% in FY09). Source: RBI, ICICI Bank ResearchPost election, deficits carry an upward bias Historical data suggests that on an average,
fiscal deficit has a tendency to rise post the
general elections, the last election being a
pleasant exception. Bulk of the increase in fiscal deficit in FY09
(increase of INR 1932 bn) has come from anincrease in the primary deficit of the center as
interest payments are expected to have risen by
approximately INR 19 bn only. The upward risk to fiscal deficit in FY10 would
emanate from a higher than expected primary
deficit.
Source: RBI, Parliament of India, ICICI Bank Research
-11 -9 -7 -5 -3 -1 1 3 5
Australia
Canada
Germany
Japan
UK
US
Brazil
Russia
India
China
Government balance as % of GDP
2008 2009 2010
0
2
4
6
8
10
12
FY82
FY84
FY86
FY88
FY90
FY92
FY94
FY96
FY98
FY00
FY02
FY04
FY06
FY08
FY10E
Fiscal deficit (as % of GDP) Center State
-2
0
2
4
6
8
10
FY8
2
FY8
4
FY8
6
FY8
8
FY9
0
FY9
2
FY9
4
FY9
6
FY9
8
FY0
0
FY0
2
FY0
4
FY0
6
FY0
8
FY1
0
BE
Fiscal deficit Primary deficit Revenue deficit
(as % of GDP)
General elections
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8/14/2019 India Outlook for FY 10
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Fiscal stimulus and deficitsFiscal stimulus varies across countries
In most countries discretionary fiscal stimulus
has so far focused on 2009, with the 2010
amounts generally representing phasedimplementation of programs initiated in 2009.
According to the IMF, for the G20 as a whole
fiscal stimulus would amount to 1.8% of GDP in
2009 and 1.3% of GDP in 2010.
Difference in the size of stimulus comes
primarily from two sources ability of the
government (i.e., the level of the deficit at which
they entered the recession) and the presence of
in-built automatic stabilizers in each economy.Source: IMF, ICICI Bank Research
Indias fiscal stimuli has so far been prompt
Fiscal stimulus in India was introduced in late
2008 and as elsewhere, it came in the form of
both an increase in expenditure as well as a cut
in taxes.
So far, a total of INR 500 bn increase in
combined government expenditure has been
earmarked under the two different stimulus
measures along with tax cuts to the tune of INR
375-400 bn.
Although not a part of any fiscal stimulus, but
schemes like the farm debt waiver and sixth
commission payouts could very well reduce theneed for aggressive fiscal stimulus.
Source: Press releases, ICICI Bank ResearchHigh deficit to support growth
Except FY09, the government had been curbing
fiscal largesse since the introduction of the
FRBM Act by trying to maintain a somewhat
counter cyclical fiscal policy structure.
Although the direction of causality between
deficit and growth is far from clear, but
nevertheless a higher deficit (or a lower surplus)
is beneficial in times of slowing economic
activity as government spending substitutes the
fall in private spending in order to sustain
aggregate demand.
Hence, a higher deficit need not always be a
macro risk (through rise in interest rates and
crowding out). It can very well be a much-
needed growth booster. Source: RBI, ICICI Bank Research
0.0
0.5
1.0
1.5
2.0
2.5
-10 -8 -6 -4 -2 0
Average government balance as % of GDP (2008-10)
Averageannounce
dfisca
lim
pluse
as
%o
fGDP(2008
-10)
India
UK Japan
Brazil
Canada
Germany Russia
Australia
China
US
S u m m a r y o f a n n o u n c e d f i sc a l s ti m u l u s m e a s u r es i n In d i a I N R b nFirst stimulus package
Increase in plan expenditure 200
Reduction in CENVAT 87
Infrastructure promotion through IIFCL 100
Scheme for textile and SMEs 14
Second stimulus package
Increase in state government expenditure 300
Increase in tax-free bond limit for IIFCL 300
Special credit line and liquidity support through SPV for NBFCs 250
FII investment in corporate debt increased to USD 15 bn from 6 bn
ECB relaxation
OthersTax cuts announced post interim budget 300
0
2
4
6
8
10
12
FY
82
FY
84
FY
86
FY
88
FY
90
FY
92
FY
94
FY
96
FY
98
FY
00
FY
02
FY
04
FY
06P
FY
08RE
FY
10BE
2
3
4
5
6
7
8
9
Real GDP Fiscal defict (inverted, RHS)(% YoY) (% of GDP)
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8/14/2019 India Outlook for FY 10
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Assessing the determinants of deficit in FY10Indirect tax revenues to be impacted further
As part of tax reforms, indirect taxes (customs
and excise) were reduced substantially since
mid 1990s resulting in fall in collections vis--vis
nominal growth.
The reduction in indirect tax rates (as a part of
fiscal stimuli) and the expected slowdown in
nominal growth to around 10% would impact
revenues from indirect taxes in FY10.
This would have an adverse impact on the tax-
to-GDP ratio, which is already depicting signs of
fatigue.
Source: RBI, ICICI Bank Research
Bleak year for direct tax revenues?
Share of direct tax revenue in gross tax revenue
is expected to increase from 55% to 57% in
FY10 we see upside risks to these estimates,
as the new government is likely to implement
stimulus measures through a reduction in
indirect tax rates (revenues from which are
generally more sensitive to slack in economic
activity).
Driven by a slightly higher fall in indirect tax
revenue, during 1997-98, tax-to-GDP ratio fell by
0.5% as nominal growth dropped from 15.7% to6.3% - this could be repeated to a lesser extent
in FY 10 as the ratio could slip towards 8% from
the expected 8.6% in FY09.Source: RBI, ICICI Bank Research
Pressure from subsidies to come off
The plunge in global commodity prices will act
as blessing for the off-balance sheet deficit that
is expected to drop from about 2.4% in FY09 to
about 0.7% in FY10.
Cash subsidy bill for the government is also
expected to come down (driven by a drop in
fertilizer subsidies) from its decade high level of
INR 1292 bn in FY09 to INR 1009 bn in FY10.
If a faster than expected recovery in global
economy escalates commodity prices, then
chance of a rise in FY10 estimate of cash
subsidy later on in the year cannot be ruled out. Source: RBI, ICICI Bank Research
5
10
15
20
25
30
35
40
45
50
FY91
FY92
FY93
FY9
4
FY9
5
FY9
6
FY9
7
FY9
8
FY9
9
FY0
0
FY0
1
FY0
2
FY0
3
FY0
4
FY0
5
FY0
6
FY0
7
14
15
16
17
18
19
20
21
22
23
24
Customs/ Imports Excise/ Industrial output (RHS)(%) (%)
6
8
10
12
14
16
18
20
FY
82
FY
84
FY
86
FY
88
FY
90
FY
92
FY
94
FY
96
FY
98
FY
00
FY
02
FY
04
FY
06
FY0
8
FY1
0BE
5.5
6.0
6.5
7.0
7.5
8.0
8.5
9.0
9.5
Nominal GDP Tax revenue (RHS)(% YoY) (% of GDP)
0
100
200
300
400
500
600
700
800
FY
01
FY
02
FY
03
FY
04
FY
05
FY
06
FY
07
FY
08
FY
09RE
FY
10BE
0
200
400
600
800
1000
1200
1400
Subsidies FoodFertilizerPetroleumOthers Total (RHS)(INR bn) (INR bn)
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8/14/2019 India Outlook for FY 10
21/45
Assessing the determinants of deficit in FY10Can higher expenditure be avoided?
Although the Indian economy has undergone
structural changes over the last two decades, a
crude analysis suggests that the correlation
between nominal growth and government
expenditure falls substantially during times of
slowdown (which implies increased government
expenditure) the average correlation
coefficient lies close to 0.4 compared to close
to 0.2 observed during expansion phases.
Higher government expenditure acts as a
natural stress reliever and is a preferred form of
fiscal stimulus, considering the relatively higher
value of fiscal multiplier over the tax multiplier.Source: RBI, ICICI Bank Research
How productive is increased expenditure?
According to the interim budget, revenue
expenditure for the government is expected to
rise above 14% of GDP in FY10 from close to
12% in FY09. This is in contrast to the fall in capital
expenditure, which is expected to drop to about
1.7% of GDP in FY10 from about 1.8% in FY09. The moderation in capital expenditure is a
concern, as it is not helping in enhancing the
productive capacity of the economy, whereas
the increase in revenue expenditure is justreflective of the increase in government
consumption through the implementation of
various stimulus measures. Source: RBI, ICICI Bank ResearchRising deficits imply larger interest payments
The difference between the gross fiscal and
primary deficit has increased by close to 2%
over the last decade primarily due to rising
interest payments.
Total interest payments are expected to
increase by INR 328 bn in FY10 this happens
to be highest single year increase.
However, what is more worrying is the
likelihood of interest payments (as percentage
of revenue receipts) rising for the second
consecutive year in FY10 after the improvement
seen since FY02.Source: RBI, ICICI Bank Research
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
Slowdown Expansion
Correlation between Growth in Nominal GDP & Expenditure
Growth in Nominal GDP & Revenue
During a slowdown phase expenditure rises but revenue
falls
8
9
10
11
12
13
14
15
FY82
FY84
FY86
FY88
FY90
FY92
FY94
FY96
FY98
FY00
FY02
FY04
FY06
FY0
8R
E
FY1
0B
E
1
2
3
4
5
6
7
8Expenditures as % of GDP Revenue Capital (RHS)
0
500
1000
1500
2000
2500
FY
81
FY
83
FY
85
FY
87
FY
89
FY
91
FY
93
FY
95
FY
97
FY
99
FY
01
FY
03
FY
05
FY
07
FY
09RE
20
25
30
35
40
45
50
55
Interest Payments - size as % of revenue receipts (RHS)(INR bn)
-
8/14/2019 India Outlook for FY 10
22/45
Issues in financing the deficitHeavy reliance on market borrowings
Since FY99, major part of the financing of the
fiscal deficit has been borne by market
borrowings. Net market borrowings (as % of fiscal deficit)
increased from the budgeted 75% to 80% in
FY09 this is expected to touch a record 93% in
FY10. Since there are significant upside risks to the
budgeted fiscal deficit estimate, this share could
even go higher however since short-term
borrowings have not been considered in the
FY10 interim budget, a part of the increase in
deficit could potentially be offset through this.
Source: RBI, ICICI Bank Research
might increase the onus on banks
The share of market borrowing in financing the
fiscal deficit has picked up after FY05.
G-sec holdings by banks (as % of outstanding)
have somewhat moderated in the four years till
FY07, with increased participation seen from
PFs and LIC.
However, with the fiscal deficit rising once again
in FY09 and FY10, the incremental appetite for
g-secs is likely to come more from the banks
side given their huge deposit base.
Source: RBI, ICICI Bank ResearchElevated yields to pose further problem
The moderation in average rate of interest on
domestic government liabilities has been
beneficial in bringing down the interest cost (as
% of receipts) after FY04.
However, there would be two factors acting
against the interest costs this year (i) the
increase in magnitude of the deficit per se will
result in higher interest costs, and (ii) buoyancy
in bond yields is expected to continue and since
majority of the financing would be through
market loans, the interest cost for the
government runs the risk of carrying an upward
bias.Source: RBI, ICICI Bank Research
Y e a rMark e tL o a n s
S m a l lS av in gs S PFs
Spec i a lDepos i t s
FY91 - FY95 (avg.) 10.86 10.85 11.63 11.53
FY96 - FY00 (avg.) 12.39 11.62 11.62 10.93
FY01 12.99 11.6 10.54 9.87
FY02 12.83 11.61 9.09 10.5
FY03 12.11 11.56 8.53 8.82
FY04 11.11 10.88 7.39 7.94
FY05 9.87 9.37 7.99 7.65
FY06 10.07 8.9 7.46 7.25
FY07 8.9 8.91 7.63 6.85
FY08 9.45 8.33 7.83 5.67
Average In teres t Rates on Outs tanding Domest i cL iab i l i ti es o f the Cen t re (%)
-20%
0%
20%
40%
60%
80%
100%
FY82
FY84
FY86
FY88
FY90
FY92
FY94
FY96
FY98
FY00
FY02
FY04
FY06
FY08RE
FY10BE
Financing of fiscal defict External sources Net market borrowings
Draw down of cash balances Others
3
4
5
6
7
8
9
FY91
FY92
FY93
FY94
FY95
FY96
FY97
FY98
FY99
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
40
45
50
55
60
65
70
75Fiscal deficit as % of GDP Banks' holding of G-Secs as % of
outstanding stock (RHS)
-
8/14/2019 India Outlook for FY 10
23/45
Monetary policy response so farLiquidity seems to be the prime concern
Even before the fiscal stimulus across the world
gained traction, deployment of monetary policy
happened in both conventional and non-
conventional forms. While growth concerns prompted easing of
policy rates, liquidity concerns and financial
stability seems to be the principal objective
behind the use of non-conventional methods. Policies dealing with toxic assets, capital
injection programs, and creditor protection in
case of further deterioration have not been
needed in the Indian context.
Source: IMF, ICICI Bank Research
RBI does the most aggressive policy easing
In the fight against the ongoing crisis, monetary
policy from the RBI indeed acted as the first
line of defense. Even before fiscal policy was considered as a
possible tool, financial stability and growth
concerns prompted the RBI to cut policy rates
aggressively - the repo and reverse repo rates
were pruned by 400 bps and 250 bps to 5% and
3.5% respectively in less than five months. Apart from this CRR and SLR were also brought
down by 400 bps and 100 bps to 5% and 24%respectively.
Source: Bloomberg, ICICI Bank Researchand infuses liquidity as well
The spillover from the ongoing global financial
crisis resulted in an unprecedented tightening of
liquidity conditions after the collapse of Lehman
Brothers, which was exacerbated by seasonal
tax outflows and fx intervention by the RBI. Since Sep-08, RBI released about INR 4300 bn
liquidity in FY09 through various measures. Further support came through in the form of a
100 bps cut in the SLR, and measures to
counter the shortage in fx liquidity (e.g., Dollar
swap line for banks, increase in rates for NRI
deposits, resumption of SMO, etc.)Source: RBI, ICICI Bank Research
Establish/
Increase
DepositInsurance
Wholesale
BorrowingGuarantees
Strengthe
ned
LiquidityMeasures
Re-
Capitalization Plans
Asset
PurchasePlans
Developed Countr iesAustralia x x x x
Canada x x x
Germany x x x x x
France x x x
Italy x x x
Japan x x x
UK x x x x x
US x x x x x
EM Countr iesBrazil x x
Russia x x x x x
India x
China x
South Korea x x x x
Conta inmentOverv iew o f po l i cy measures
Resolut ion
Measure/ Facility Size (INR bn)
CRR cuts 1600
MSS unwinding 631
Term repo facility 600
Increase in export credit refinance 255
Special refinance facility 385Refinance facility for SIDBI/NHB/EXIM 160
Liquidity facility for NBFCs 250
OMO purchases 466
Total 4347
Actual/ Potential release of liquidity since Sep-08
3
4
5
6
7
8
9
10
M
ar-05
Sep-05
M
ar-06
Sep-06
M
ar-07
Sep-07
M
ar-08
Sep-08
M
ar-09
Policy rates Repo Reverse Repo CRR(%)
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8/14/2019 India Outlook for FY 10
24/45
Quantitative Easing and the RBICentral banks expanding their balance sheets
Various policy initiatives taken by the central
banks are resulting in an expansion of their
balance sheets.
Since Sep-08, the Fed started increasing its
balance sheet size through purchases of assets
of different types and maturities. Similarly, the
BoE has also increased its balance sheet size by
implementing various schemes like the Asset
Purchase Facility. Monetization of government debt through
buying of treasuries and corporate bonds by
Fed, BoE, BoJ, SNB, etc. would further lead to
an expansion in their balance sheet size.Source: Bloomberg, CEIC, ICICI Bank Research
RBIs version of QE
Although RBI has not bought any private
securities from the market, the effect of the
ongoing monetization of government deficit
would be reflected in its balance sheet. OMOs till date have been the preferred route of
monetization of deficit since possibility of
private placement has been shrouded in
mystery. Stock of Rupee securities held with the
RBI increased by INR 383 bn in FY09. Changes in other parts of the balance sheet
would most likely be of little significance inFY10.
Source: CEIC, ICICI Bank ResearchMoney multiplier spikes up
Money multiplier has lied between 4.5 5.0 for
most part of last seven years. However, the aggressive amount of monetary
easing in the form of cuts in the CRR (which was
pruned by 400 bps in just about three months)
resulted in a sharp spike in the money
multiplier, thereby pushing it to an all time high. Since the RBI could resort to further CRR cuts if
required, money multiplier could possibly stay
in a higher range in FY10. Any effort to expand
RBI balance sheet would result in liquidity
infusion unlike other countries where this
transmission mechanism has failed.Source: CEIC, ICICI Bank Research
3.7
3.9
4.1
4.3
4.5
4.7
4.9
5.1
5.3
Mar-
99
Mar-
00
Mar-
01
Mar-
02
Mar-
03
Mar-
04
Mar-
05
Mar-
06
Mar-
07
Mar-
08
4
5
6
7
8
9
10
11
Money Mu ltiplier CRR (%, inverted, RHS)
50
100
150
200
250
300
M
ay-06
Aug-06
Nov-06
Feb-07
M
ay-07
Aug-07
Nov-07
Feb-08
M
ay-08
Aug-08
Nov-08
Feb-09
700
900
1100
1300
1500
1700
1900
2100
2300
BoE's asset size Fed's asset size (RHS)(GBP bn) (USD bn)
6000
7000
8000
9000
10000
11000
12000
13000
14000
15000
16000
Mar-06
Jun-06
Sep-06
Dec-06
Mar-07
Jun-07
Sep-07
Dec-07
Mar-08
Jun-08
Sep-08
Dec-08
Mar-09
RBI's Assets - FCA Gold Rupee securities (incl T-Bills) Others(INR bn)
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8/14/2019 India Outlook for FY 10
25/45
Forecasting key monetary variables
Source: CEIC, ICICI Bank Research
Source: CEIC, ICICI Bank Research
Source: CEIC, ICICI Bank Research Source: CEIC, ICICI Bank ResearchMeasures of money supply could carry an upside risk in FY10
Although net foreign exchange assets and net non-monetary liabilities of RBI were the major
drivers of M0 in FY09, their significance would reduce dramatically in FY10 as no significant net
foreign inflows are expected (see our BoP forecast below for details). RBIs credit to the
government gained importance in FY09 because of the temporary immunity from FRBM leading to
the start of monetization of fiscal deficit and also because of the depletion of the MSS stock. Both
these trends are expected to gather pace in FY10.
The impact of this expansion would get reflected in net bank credit to government, which wouldfinally affect M3. In our opinion, the expansion in net bank credit to government would offset the
decline in bank credit to the commercial sector on the back of falling nominal growth in FY10.
This expansion in M3 will eventually be reflected in an increase in aggregate deposits of the
banking system.
-5000
-3000
-1000
1000
3000
5000
7000
9000
11000
13000
15000
M
ar-99
M
ar-00
M
ar-01
M
ar-02
M
ar-03
M
ar-04
M
ar-05
M
ar-06
M
ar-07
M
ar-08
M
ar-09
Sources of M0 - Net RBI credit to govt NFA of RBI NNML of RBI(INR bn)
1000
2000
3000
4000
5000
6000
7000
8000
9000
10000
M
ar-99
M
ar-00
M
ar-01
M
ar-02
M
ar-03
M
ar-04
M
ar-05
M
ar-06
M
ar-07
M
ar-08
M
ar-09
Components of M0(INR bn)
Currency in circulation Bankers' deposit with RBI
-10000
0
10000
20000
30000
40000
50000
60000
M
ar-99
M
ar-00
M
ar-01
M
ar-02
M
ar-03
M
ar-04
M
ar-05
M
ar-06
M
ar-07
M
ar-08
M
ar-09
Sources of M3 - Net bank credit to govt Bank credit
to comm sector NFA of banks NNML of banks
(INR bn)
0
5000
10000
15000
20000
25000
30000
35000
40000
45000
50000
M
ar-99
M
ar-00
M
ar-01
M
ar-02
M
ar-03
M
ar-04
M
ar-05
M
ar-06
M
ar-07
M
ar-08
M
ar-09
Components of M3 - Currency with public Demand
dep with banks Time dep with banks
(INR bn)
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8/14/2019 India Outlook for FY 10
26/45
Path of key monetary and credit ratiosInvestments to increase as
The pick-up in credit-to-M3 ratio since FY05 was
associated not only with a higher growth for the
economy, but also with an improvement in
financial deepening.
Going forward, although we expect the ratio of
aggregate deposits-to-M3 to remain around
80%, credit-to-M3 ratio is likely to moderate to
below 60% (for reasons enumerated above).
The effect of this decline would be somewhat
offset by an increase in the investment-to-M3
ratio that can be expected to almost touch 26%
in FY10.
Source: CEIC, ICICI Bank Research
credit offtake is expected to moderate
As growth slows down further, credit demand
would moderate further at the same time the
supply of credit would also come down as
banks are expected to become more risk
averse. The fall in the credit-deposit ratio would also be
driven by deposit growth, which can be
expected to remain buoyant on the face of RBIs
monetization.
Investment-deposit ratio could turn marginallyhigher as banks are expected to increase their
holding of excess SLR.Source: RBI, ICICI Bank Research
Structure of RBI balance sheet to get altered
FY10 could end up being a unique year as
temporary immunity from the FRBM act will
allow RBI to monetize governments fiscal
deficit.
Since BoP is expected to remain close to zero
next year, the result would be an expansion of
net domestic assets of the RBI vis--vis its netforeign assets.
We expect the ratio of RBIs NDA-to-NFA, which
started increasing in FY09, to become positive
and increase further in FY10.
The increase in this ratio would be vital for
providing cushion to the economy suffering
from a withdrawal in economic activity. Source: CEIC, ICICI Bank Research
0.70
0.72
0.74
0.76
0.78
0.80
0.82
Mar-99
Mar-00
Mar-01
Mar-02
Mar-03
Mar-04
Mar-05
Mar-06
Mar-07
Mar-08
Mar-09
0.20
0.25
0.30
0.35
0.40
0.45
0.50
0.55
0.60
0.65Ratios - Deposits/M3 Credit/M3 (RHS) Investments/M3 (RHS)
0
20
40
60
80
100
120
140
FY82
FY84
FY86
FY88
FY90
FY92
FY94
FY96
FY98
FY00
FY02
FY04
FY06
FY08
FY10E
-10
0
10
20
30
40
50
60
70
Incremental ratios Credit-DepositInvestment-Deposit (inverted, RHS)
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
Mar-
00
Mar-
01
Mar-
02
Mar-
03
Mar-
04
Mar-
05
Mar-
06
Mar-
07
Mar-
08
Mar-
09
Ratio of NDA to NFA of RBI
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8/14/2019 India Outlook for FY 10
27/45
Framework for analyzing monetary policy stance
Source: CEIC, ICICI Bank Research
Source: RBI, ICICI Bank ResearchLiquidity provision to remain key for RBI in FY10
We have envisaged two plausible on-balance sheet deficit scenarios - A and B for FY10, wherein A
corresponds to 7% of GDP and B corresponds to 8% of GDP (for details see the fiscal section).
RBIs pump priming carries the potential to keep growth in M3 and deposits at a robust level. The
only monetary variable that can be expected to moderate would be credit.
On the supply side, credit growth is expected to come off as banks generally become more cautious
in their lending activities, while on the demand side fall in input costs and a overall slowdown in
activity would tend to dampen demand for credit. Apart from sounding concerned on growth, RBI has become extremely cautious about financial
stability and hence liquidity management would continue to enjoy paramount importance. Since we expect FY10 BoP to remain close to zero, currency with the public would become the most
important driver of liquidity. Any possible sell side intervention by the RBI in the beginning of the year
would possibly be offset by a reverse transaction later (please refer to our Rupee view below).
Management of liquidity would come in the form of bond purchases under OMO and a depletion of
the MSS stock.
CRR would be deployed only if liquidity conditions begin to tighten despite these efforts.
Additionally we expect 50-100 bps cut in the repo and reverse repo rates.
FY 07 FY 0 8 FY 0 9S c en A S c en B
A . D r iv e r s o f L iq u id ity 623 2040 -416 -111 7 -1117RBI's net purchase from ADs 1190 3121 227 0 0
Currency with the public -698 -846 -993 -1167 -1167
Centre's surplus cash balances with RBI -12 -266 300 0 0
Others 142 31 50 50 50
B. M a n a g e m en t o f L iq u id ity -243 -1177 2 861 279 8 3197Change in LAF balances 364 212 576 776 676
Change in net OMO 7 135 466 1142 1641
Change in MSS outstanding -339 -1054 796 880 880
Liquidity impact of CRR changes -275 -470 1023 0 0
C . Ba n k Reser v es (A + B) 3 80 86 3 244 5 168 1 208 0
F Y 1 0R B I 's L iq u id i ty M an agem en t O p er a t io n s ( I NR b n )
(+) indicates injection and (-) indicates absorption
INR bn % INR bn % INR bn % INR bn % INR bn %
MO 1360 24 2194 31 595 6.4 561 6 1010 10
M3 5807 21 6964 21 7512 19 7497 16 3502 20
Aggregate Deposits 5029 24 5802 22 6320 20 5927 15 7763 20
Credit 4241 28 4173 22 5167 22 4011 14 4870 17
FY10 (Scen B)Changes in Key monetary variables
FY07 FY08 FY09 FY10 (Scen A)
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8/14/2019 India Outlook for FY 10
28/45
Fundamental factors affecting bond yieldsEffect of monetary policy on bonds diluted
Although we expect further policy easing from
the RBI, but it is likely to be of less significance
for bond yields as long as supply concerns
continue to dominate sentiment.
The effect of aggressive policy easing was
limited only till Q3 FY09 after which the 10Y g-
sec yields climbed up by more than 180 bps. Although, the 10Y benchmark bond yield barely
stayed within the LAF corridor over the last two
years, its average spread above the repo rate
stayed at just 12 bps between Dec-06 to Dec-08.
Source: Bloomberg, CEIC, ICICI Bank Research
as 10Y stays much above policy rates
The average spread of 10Y bond yield over the
repo rate increased to about 72 bps in Q4 FY09,
while the current spread would be close to 200
bps. Such a high level of spread with the policy rate
is not very common Data since Jun-00 suggests that the 10Y bond
yield has stayed 150 bps above the repo rate
only 2% of the time. However, if we consider the entire LAF width
(which currently is at 150 bps) as the spread,then the frequency turns out to be 16%.
Source: Bloomberg, ICICI Bank ResearchEffect of inflation and oil could also ease
Apart from policy rates, inflation and oil price
are other traditionally important drivers of bond
yields.
With both staying low for the time being, the
high level of long-term correlation with bond
yields can be expected to moderate in FY10.
However, there is a slim possibility that theglobal economy starts to recover in early 2010,
and with the ongoing monetization in most of
the countries inflation could become a possible
threat thereafter this could restore the long
term correlation to higher levels once again.Source: Bloomberg, ICICI Bank Research
-1.00
-0.75
-0.50
-0.25
0.00
0.25
0.50
0.75
1.00
Mar-
00
Mar-
01
Mar-
02
Mar-
03
Mar-
04
Mar-
05
Mar-
06
Mar-
07
Mar-
08
Mar-
09
1Y rolling correlation of 10Y G-Sec yield with WPI and Oil price
Frequency (%)
Above 50 bps 52
Above 100 bps 20
Above 150 bps 2
Greater than 1/3 LAF 50
Greater than 2/3 LAF 34
Greater than LAF 16
* Data since Jun-00
Spread of 10Y G-Sec above reporate*
3
4
5
6
7
8
910
11
M
ar-01
M
ar-02
M
ar-03
M
ar-04
M
ar-05
M
ar-06
M
ar-07
M
ar-08
M
ar-09
Repo Rate Reverse Repo Rate 10Y G-Sec Yield(%)
-
8/14/2019 India Outlook for FY 10
29/45
Bond market outlook
Source: RBI, ICICI Bank Research
Source: RBI, CEIC, ICICI Bank Research Source: RBI, ICICI Bank ResearchRBI actions to tackle excess supply and the outlook for bonds
In the first part of FY10, fundamental factors might play a very limited role in determining bond yields.
We have noticed that in the last quarter of FY09 excess supply emerged as the key factor which kept
sentiment at bay. Even in FY10, the overall supply of g-secs could potentially lie between INR 3900-
5000 bn this would be about 23%-58% higher than the net supply in FY09.
The overall demand-supply balance does not look that threatening because of heavy OMO purchase by
RBI in H1. Such a trend is expected to continue in H2 as well.
However, since fiscal slippage is expected to be much higher (1.5-2.5% of GDP), market is factoring ina risk of the supply-demand balance getting