Growth Upturn To Gain Traction In FY2013/14
BMI View: We remain above consensus on India's economic growth outlook, calling for headline expansion of 5.5% and 6.1% for FY2012/13 and FY2013/14 (versus market expectations of 5.3% and 5.5%, respectively). Conditions are sufficiently ripe for investment spending to lead a growth upturn, aided at the margin by an improving export performance. That said, the government's persistent fiscal failings will prevent a more pronounced growth recovery, by keeping interest rates high and weighing on overall investor sentiment. A possible ratings downgrade, while not our core scenario, is arguably the greatest risk to our benign outlook.
Despite struggling to gain a solid footing in the latter half of 2012, we believe that the Indian economy is well poised to see an upturn in real GDP growth in the final quarter of FY2012/13 (April-March) and into FY2013/14. We are forecasting headline expansion of 5.5% and 6.1% for FY2012/13 and FY2013/14, which, as the accompanying chart shows, makes us more constructive on India's growth story than consensus.
|India - Real GDP Growth, %|
To be sure, there is an assortment of significant economic data that suggest a growth upturn is already underway. Firstly, India's manufacturing purchasing managers index (PMI) came in at a six-month high of 54.7 in December, while the services metric registered a healthy outturn of 55.6. Taken together as a simple average, these PMI figures would suggest a decent finish to the year for the Indian economy. Secondly, the OECD's composite leading indicator (CLI) provides further confirmation of a bottoming out of the economy (see chart). Finally, we note the pervasive strength of India's equity market, which, as we have shown in the past, provides strong leadership for industrial production trends. The benchmark Sensex soared to its highest level in two years in early January, with cyclical stocks driving market gains (a bullish macro signal, in our view).
|Rebound In The Works|
|India - Average PMI & OECD Composite Leading Indicator|
From our perspective, conditions are sufficiently ripe for investment spending to lead an upturn in overall economic growth. Below, we outline some of the factors underpinning this view.
RBI On The Cusp Of Easing: The recent retreat in price pressures will provide the Reserve Bank of India (RBI) room to cut rates by at least 50 basis point in the coming months, which should provide a decent tailwind to investment activity. Wholesale price inflation (WPI) came in at a 36-month low of 7.2% year-on-year (y-o-y) in December on the back of a retreat in core price pressures (non-food and fuel items increased by just 5.0% y-o-y). Moreover, when measured on an annualised m-o-m 3mma basis, wholesale prices actually fell (by 0.5%) for the first time since March 2009. This should provide the RBI with sufficient comfort to start monetary easing before long, probably in two 25bps installments. Financial conditions have already started to ease, with AAA-rate corporate bond yields falling 80bps since September 2012.
|Ready, Steady, Cut|
|India - Inflation, Interest Rates & Bond Yields, %|
Business Confidence Improving: After falling for most of 2012, business confidence readings appear not only to have stabilised, but also to have exhibited some mild improvements in areas such as sales and profit outlooks and new orders. And after several years on the defensive, we believe that both local and foreign firms may look to resume capital spending plans this year. Domestic and external financial conditions are conducive, return on investment remains attractive, and, crucially, the government has made efforts to expedite project approvals, liberalise investment regimes, and delay the controversial retrospective tax legislation on foreign companies. The recent 'Vibrant Gujarat' summit has seen over INR1.6trn (US$29.4bn) in investment commitments, with Reliance Industries, India's largest conglomerate, pledging INR1trn over the next three years. We note that foreign direct investment (FDI) has been on a upward trajectory for a few quarters now, and now stands at all-time highs on a 12-month moving average basis.
|India - Foreign Direct Investment Inflows, US$bn (12mma)|
Re-Stocking Boost In Order: Even if our expectations of a capex upturn are not forthcoming, Indian companies will have to invest in new inventory as part of the natural restocking cycle. To be sure, we have seen three straight quarters of negative year-on-year growth in stock building for the first time since the 2008-09 global downturn, and replenishment looks to be well overdue.
Exports To Help At The Margin
Our global outlook has brightened somewhat of late due to upward revisions in our China and US 2013 growth forecasts. This should provide some relief to Indian exporters, who have struggled of late. To be sure, we note that India is significantly exposed to the eurozone economy (accounting for roughly a fifth of exports), but even the currency bloc has seen tail risks soften somewhat and there is a chance that growth could surprise extremely deflated expectations. India's service exports, meanwhile, stand to do quite well from a potential pick-up in the US corporate capex cycle. On balance, we believe that net exports will at the very least not provide a drag to headline growth, and could possible act as a positive tailwind for the first half of FY2013/14.
Risks To Outlook: Politics As Usual
Despite our sanguine outlook, we are not expecting a particularly forceful recovery in economic growth in the coming fiscal year. To be sure, our FY2013/14 real GDP growth forecast of 6.1% would be well below the 10-year trend growth rate of 8.0%. While a weaker external climate goes some way to explain this, we believe that the government's persistent fiscal failings are perhaps the largest impediment to stronger growth. To be sure, New Delhi's failure to rein in the fiscal deficit has been a major reason behind India's struggles with stubborn inflation, historically high interest rates and a record current account shortfall. These factors have, in turn, exhausted investor patience with India's growth story.
In a worst case scenario, in which the government fails to make any progress on deficit reduction in the coming months, there is a possibility that India will lose its coveted investment grade status. Indeed, Fitch Ratings and Standard & Poor's, two of the 'Big Three' agencies, have already sounded out warnings on this front. A downgrade to junk would knock any nascent investment rebound off track, and potentially see Indian real GDP growth languish in the low-to-mid single digits for an extended period.