BMI's Executive Summary

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From Q108 we will be calculating the Commercial Banking Business Environment Rating (CBBER) for each of the countries surveyed by BMI. This will permit a more systematic and comprehensive comparison of the conditions within the banking industries of the various countries than was possible in the past. For each country, it will also facilitate a comparison of the conditions within the banking sector and conditions prevailing in other sectors.

India's overall CBBER, at 58.6, is towards the middle of the countries in the Asia Pacific region that are surveyed by BMI. However, this is largely due to the comparatively high at 76.3 score on the heavily weighted banking market elements of the limits to potential returns element. This, in turn, is reflective of the sheer scale and entrenched position of the Indian banking system rather than its high level of development.

In particular, the banking market elements of the limits to potential returns have a much higher score than the country elements (76.3 versus 33.2). In particular, the low levels of GDP per capita are a very significant constraint on returns within the banking sector. This is not to say that there are not also very significant constraints limiting the realization of returns within the banking sector itself. Indeed, in the CBBER rating for India the banking market elements of the risks to the realisation of returns are less than the than the country risk rating (53.3 versus 60.2). That is, although the banking sector is well positioned within the economy in general, it, rather than the economy more generally, is also the primary locus of risks to its own further development. This is because, although well regulated and protected, India's banking system remains comparatively backward, relying upon paper-based payment systems, and hampered by a cumbersome legal system.

Despite an anticipated moderation in India's growth momentum, we see upside risks to our 8.2% growth forecast for FY2007/08. Weak infrastructure will continue to impose restraints on the country's growth potential in the long term, while the recent global credit crunch will see the central bank maintain a tight policy bias.

On the whole it appears as though economic growth will begin to moderate in the coming quarters. This is because we expect a tight monetary policy to eventually impact on demand, while the risk of a sharper deceleration will present itself if the US subprime crisis persists. That said, given last year's robust growth rate of 9.4% – which will have a positive spillover effect on the Indian economy – we do acknowledge upside risks to our 8.2% growth forecast for FY07/08.

Indian consumers have been resilient to the Reserve Bank of India (RBI)'s rate hikes in large part due to a dramatic growth in incomes. But despite a falling inflation rate (wholesale price inflation fell below 4.00% for the first time in over a year, to 3.26% in the week to September 29), we expect the central bankto maintain a strong tightening bias, especially in light of the latest GDP data. In its annual report released on August 30, the central bank forewarned of an increase in price pressures, due to shortfalls in farm production and infrastructure, which would spur inflation and curb growth.

Overall, growth momentum is still expected to remain notable, despite the anticipated slowdown. If growth for the fiscal year does reach the central bank's forecast 8.5% expansion rate, this will only be marginally below the 8.6% average achieved over the past four years. Inflation remains the biggest threat to this outlook, and supply-side factors, if not dealt with appropriately, will render these growth rates unsustainable.