In India, infrastructure development and the accompanying increase in foreign direct investment (FDI) are fuelling construction and capital investment demand. While an increase in imports of intermediate goods has kept the current account in deficit, the country has maintained a capital account surplus that is larger than its current account deficit. We expect the Reserve Bank of India (RBI) to continue to intervene by selling rupees, in a bid to avoid rapid rupee appreciation. Any excess domestic liquidity generated by rupee selling should lift domestic demand, amid continued buoyant construction and capital investment demand.
Our view now versus three months ago
We have slightly lowered our real GDP growth forecast to reflect concern about a US economic slowdown. We now expect India’s current account deficit to widen further, factoring in a softer US economy and lofty oil prices. We have raised our wholesale price growth rate estimate, assuming an increase in domestic gasoline prices.
Summary
We expect real GDP growth to slow slightly in FY07-08F, in view of: the prospects for both rupee strength and monetary tightening; and concern about the US economy. Yet, we believe that demand for infrastructure projects, including the Delhi-Mumbai
Industrial Corridor (DMIC) project, will remain strong. Plus, domestic demand growth, particularly in the construction industry, appears robust. The current account deficit is likely to widen in FY08-09F on greater demand for imported capital goods and intermediate goods, in tandem with a rise in import prices caused by high crude oil prices. Nevertheless, we believe the country will maintain a substantial capital account surplus, amid FDI increases associated with infrastructure development. This should add to currency appreciation pressure.
While a strong rupee should limit inflation, we expect the central bank will continue to sell rupees to hold back currency appreciation, so as to help export pricing — especially in labour-intensive sectors such as textiles. This currency intervention may generate excess domestic liquidity by lifting the money supply. The central bank will probably try to absorb this excess liquidity by raising the cash reserve ratio in order to prevent bank lending from overheating. Still, we do not see the RBI raising interest rates, since this could prompt an inflow of speculative funds attracted by interest rate differentials. On the other hand, now that the US has cut interest rates sharply, the RBI
Infrastructure development driving growth
We cut our growth forecast a little, reflecting concern about a slower US economy and lofty crude oil prices
We have slightly lowered our growth forecast but believe the economy will retain momentum
Economics | India Tetsuji Sano
might conceivably pare rates to narrow the interest rate spread. We expect rupee selling to mitigate appreciation pressure and forecast INR38.0-INR44.0 at end-FY07F, INR37.0-INR42.0 at end-FY08F and INR36.0-41.0 at end-FY09F.
Real economy developments and directions
We expect economic growth, particularly factory output growth, to slow slightly in the face of: the strong rupee and monetary tightening; and concern about the US economy.
We expect domestic gasoline prices to rise slightly in FY08F, and have lowered our real GDP growth forecasts to 9.0%, from 9.1%, for FY07F, and to 8.9%, from 9.2%, for FY08F. India is beginning to upgrade its infrastructure, however, and this is fostering growth in construction and capital investment demand. The DMIC project is scheduled to start in 2008, at the earliest, and we estimate that it will involve investment of US$90bn over nine years. We expect this to bring about a virtuous cycle, with infrastructure upgrades spurring further FDI.
We also forecast plentiful farm output in FY07F, in light of heavy rains during the June to September monsoon season. The limitations of India’s irrigation infrastructure mean that agricultural production is still heavily influenced by rainfall during the monsoon season. We expect agricultural production growth to be more stable as the country’s irrigation infrastructure is enhanced. We believe India might come close to achieving the government’s target of 9% average annual real GDP growth in its 11th five-year plan, which kicked off in FY07F.
The value of India’s imports should continue to grow rapidly, in view of the expected increase in construction and capital investment demand. In April-November 2007, the value of goods imports excluding crude oil expanded by 35.2% y-y on a dollar-denominated basis. We expect the trade deficit to widen in FY09F, as imports of intermediate and capital goods are likely to expand further with the upgrading of infrastructure from FY08F. Although we expect the services balance and the transfer account balance to remain in surplus, we forecast the current account deficit will widen to US$21.4bn in FY07F, US$40.5bn in FY08F, and US$46.8bn in FY09F.
Fiscal policy
The central government’s budget calls for a 17.0% increase in expenditure in FY07F, up from a 14.9% increase in FY06, indicating that fiscal policy will continue to stimulate the economy. We see economic stimulation continuing in FY08-09F on double-digit pa growth in government spending. The central government’s budget is governed by the Fiscal Responsibility and Budget Management Bill, according to which the fiscal deficit up to end-FY09F must be within 3% of GDP. There is a risk that domestic fuel
subsidies might cause the fiscal deficit to widen, but the FY07F fiscal deficit in the eight months through to November 2007 equated to 63.8% of the full-year budget, below the eight-month figure of 67% based on the simple average. With government income likely to see robust growth from the strong economy, we do not expect the fiscal deficit to expand relative to GDP.
Monetary policy and interest rates
We project a slowdown in the rate of increase in wholesale prices in FY07F, amid measures to reduce energy-related prices. The government controls the price of oil products, such as gasoline, through an official price system. Despite rising crude oil prices, the government cut gasoline prices by around 4% on 29 November, 2006, and by another 4% or so on 15 February, 2007. From now on, we expect inflationary pressures to build gradually as a result of demand-side factors as the economy performs well. We also expect the government to raise gasoline prices slightly in FY08F. Nevertheless, a strong rupee should limit wholesale price inflation. We forecast wholesale prices will rise by 4.2% in FY07, 4.9% in FY08F and 5.0% in FY09F.
Economic momentum to be maintained on infrastructure development
We project a widening current account deficit on growing construction and capital investment demand
We expect further economic stimulation from fiscal policy
Wholesale price inflation to accelerate gradually
Economics | India Tetsuji Sano
We think that the RBI’s monetary policy is based on a balanced view of the economy, money supply and prices. The key economic indicators: real GDP growth (year-on-year), M3 growth for money supply and growth in the wholesale price index for prices.
Real GDP and M3 growth outpaced the RBI’s forecasts in FY06, and will probably continue to do so, as ongoing rupee selling is likely to boost the money supply. This is despite a string of tightening measures, including rate hikes and the raising of the cash reserve ratio on 23 December, 2006, 6 January, 2007, 14 April, 2007, and 28 April, 2007.
On the other hand, because wholesale price inflation is very likely to fall short of the RBI’s projection of 5.0% for FY07F, some people are now expecting the RBI to cut rates as early as its regular monetary policy review meeting in April. We, however, look for it to maintain a tight monetary stance as long as money supply remains higher than expected, for the reasons set out above. In our view, the RBI is reluctant to implement monetary tightening by way of interest rate hikes because of concerns that an inflow of speculative funds targeting interest rate differentials might make the problem of excess liquidity more serious.
Rather than raising the policy interest rate, we think the central bank will opt to raise the cash reserve ratio. However, the US Federal Reserve’s substantial rate cuts have further increased the interest rate spread between the US and India, and this could halt the widening of spreads between US Treasuries and emerging-market bonds, or even cause them to narrow. If this happens, the inflow of funds into India might accelerate.
On the basis of the interest rate spread between India and the US, an Indian interest rate cut is possible.
Forex policy and outlook
Looking at the international balance of payments in 3Q07, a current account deficit of US$5.5bn was countered by a capital account surplus of US$34.8bn (including errors and omissions). This implies upward pressure on the rupee. The RBI has indicated its intention to rein in inflation by accepting some degree of rupee appreciation since April 2007, and net buying of Indian equities by foreign institutional investors was still high in 4Q07, at US$5.0bn, following on from US$7.9bn in 3Q07. Foreign investors turned into net sellers of Indian equities in November because of the restrictions on participatory notes announced on 25 October, 2007, but in December they were net buyers once again, indicating that the impact of the introduction of restrictions on participatory notes in terms of weakening share prices and the rupee might not be substantial.
The RBI’s aversion to excessive rupee appreciation, however, is prompting it to intervene by selling the local currency. We think rising FDI attracted by infrastructure improvements will push the capital account surplus even higher, and expect continued gradual appreciation of the rupee against the greenback.
Risks
There is speculation in Indian political circles that the lower house might be dissolved and a general election called before its term is due to expire in May 2009. It is true that the ruling collation’s ability to run parliament effectively hinges on the cooperation of the four left-wing parties, because it does not have a majority in the lower house. At the same time, however, the four left-wing parties effectively have the casting vote on major policy decisions, otherwise they might stop cooperating with the ruling collation.
We expect the RBI to maintain a tight monetary stance
Capital inflows to continue to put upward pressure on the rupee
Risk of lower house dissolution has receded but not disappeared
Economics | India Tetsuji Sano
After the US and India announced the US-India nuclear cooperation agreement in July 2007, the left-wing parties mounted a campaign of fierce opposition to this agreement.
Because of this, the risk of dissolution of the lower house increased in the summer of 2007, and we think opposition parities began to prepare for a potential general election.
This campaign of opposition by left-wing parties, though, has gone on the back burner since US Treasury Secretary Henry Paulson visited India in late October. If the left-wing parties withdraw their support for the ruling coalition and Prime Minister Singh is forced to dissolve parliament, we believe the opposition parties are likely to put up a fight in the ensuing general election. Because the left-wing parties cannot join forces with either the Conservative Party, the largest opposition party, or the BJP, to which they are opposed, we think it is now more difficult for them to express strong opposition to the ruling coalition.
Structural developments
According to a survey of Japanese companies published by the Japan Bank for International Cooperation (JBIC) at end-November 2007, India has overtaken China as the most promising target for the development of their businesses over the next 10 years. The bank also revealed that Japanese companies rate India as the most important target for investment.
At the same time, Japanese companies have been slow to expand into India compared with their moves in other Asian countries. At end-2006, a total of 216 Japanese
companies had expanded into India (on the basis of stakes of 10% or more and excluding companies that had withdrawn from India and those whose investments were dormant). This compares with 4,757 companies for China, 1,575 for Thailand, 1,129 for Hong Kong and 1,029 for Singapore. The main factor discouraging Japanese companies from expanding into India has been its infrastructure. However, the
Japanese and Indian governments are working on the DMIC project, as one of a number of infrastructure projects, as well others under Economic Partnership Agreements. If progress is made in developing India’s infrastructure, Japanese companies’ expansion into India might gather steam in the next few years.
Long-term business development:
India is the most promising target for Japanese companies shifting from China
Economics | India Tetsuji Sano
India — 1
Exhibit 161. Real GDP Exhibit 162. Foreign trade
(4) (2) 0 2 4 6 8 10 12
01 02 03 04 05 06 07
Tertiary industry Secondary industry Primary industry Real GDP (% y-y)
(70) (60) (50) (40) (30) (20) (10)0 10 20 30 40 50 60 70
01 02 03 04 05 06 07
(7,000) (5,000) (3,000) (1,000) 1,000 3,000 5,000 7,000 Trade balance（RHS)
Exports（LHS) Imports（LHS)
(US$mn) (% y-y, 3MMA)
-Solid economic expansion
-Trade deficit should widen
Exhibit 163. WPI Exhibit 164. Interest rate
(5) 0 5 10 15
02 03 04 05 06 07
WPI
Fuel, Power, Light & Lubricants Manufactured Products Primary Articles (% y-y)
0 2 4 6 8 10 12
01 02 03 04 05 06 07 08
Repo rate Reverse repo rate (%)
-WPI growth rate has stabilised
-We think the RBI will hesitate before raising interest rates
Exhibit 165. Foreign exchange rate — INR:US$1 Exhibit 166. Stock price index: SENSEX30
39 40 41 42 43 44 45 46 47 48 49 50
01 02 03 04 05 06 07 08
(INR:US$1)
INR appreciation
2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 18,000 20,000 22,000
01 02 03 04 05 06 07 08
SENSEX30
-INR is still expected to face appreciation pressure
-Equity markets have fallen
Source: Central Statistical Organisation, Ministry of Commerce and Industry, Reserve Bank of India, Mumbai Stock Exchange and others
Economics | India Tetsuji Sano
India charts — 2
Exhibit 167. Money supply Exhibit 168. Fiscal balance
10 15 20 25 30 35 40 45
03 04 05 06 07
Bank credit (non-food) M3
(% y-y)
FY04 FY05 FY06 FY07
(INRbn) Actual Actual Actual Budget Revenue 3,725 3,597 4,293 5,296 (% y-y) 7.1 (3.4) 19.4 23.4 Tax revenue 2,248 2,703 3,460 4,039 (% y-y) 1476.8 894.2 833.4 1257.0 Expenditure 4,977 5,061 5,816 6,805
(% y-y) 5.6 1.7 14.9 17.0
Interest payments 1,269 1,300 1,462 1,590 (% y-y) 2.3 2.4 12.4 8.8 Primary balance 17 (138) (61) 80
(% GDP) 0.1 (0.4) (0.1) 0.2
Fiscal balance (1,252) (1,464) (1,523) (1,509) (% GDP) (4.0) (4.1) (3.7) (3.3) Note: Fiscal year starts in April and ends in March of the next year
Primary balance = fiscal balance + interest payments
-Money supply has expanded firmly
-Fiscal policy is expected to stimulate domestic demand
Exhibit 169. Auto production and sale Exhibit 170. Politics
(30) (20) (10) 0 10 20 30 40 50 60
03 04 05 06 07
Auto production index Auto sale
(% y-y)
Name Number of seats
United Progressive Alliance (ruling parties) 230
Indian National Congress INC 150
National People's Party RJD 24
Dravida Munnetra Kazhagam DMK 16
Others 38
National Democratic Alliance (opposition parties)
Indian People's Party BJP 130
Shiv Sena (Army of Shiva) SS 12
Biju People's Party BJD 11
Others 22
Cooperative Left Parties
Communist Party of India (Marxist) CPI(M) 43
Communist Party of India CPI 10
Revolutionary Socialist Party RSP 3
All India Forward Bloc FBL 3
Others 79
Vacant 3 Total 545
-Auto sales have slowed due to rate hikes
-Ruling parties do not have a majority
Exhibit 171. Rainfall Exhibit 172. Capital and financial account
(20) (15) (10) (5) 0 5 10
02 03 04 05 06 07
(10) (5) 0 5 10 Departure rate (LHS) 15
Primary sector real GDP (RHS)
(%) (% y-y)
(5) 0 5 10 15 20 25 30 35
01 02 03 04 05 06 07
Others Loans
Portfolio Investment Foreign direct investment Capital & financial account (US$bn)
↑ Inflow
↓ Outflow
-More rainfall should push up agri-production
-Capital and financial account balance: huge surplus
Note: Exhibit 12 — departure rate refers to the difference between forecast rainfall and actual
Source: Central Statistical Organisation, Reserve Bank of India, Lower House of Indian Parliament, Ministry of Finance, Indian Parliament
Economics | India Tetsuji Sano
Exhibit 173. India: macroeconomic data and Nomura forecasts
FY02 FY03 FY04 FY05 FY06 FY07F FY08F FY09F
National accounts (real, % y-y)
GDP 3.8 8.5 7.5 9.4 9.6 9.0 8.9 9.3
Private consumption 2.7 5.8 5.2 8.7 7.1 N/A N/A N/A
Public consumption (0.4) 2.6 2.6 5.4 6.2 N/A N/A N/A
Gross fixed capital formation 8.7 13.1 11.8 26.1 15.1 N/A N/A N/A Exports, goods & services 21.8 5.8 28.1 14.8 18.9 N/A N/A N/A Imports, goods & services 10.4 16.8 16.0 45.6 24.5 N/A N/A N/A
Primary industry (7.2) 10.0 0.0 5.9 3.8 5.0 4.0 4.0
Secondary industry 7.1 7.4 10.3 10.1 11.0 9.4 10.0 11.1
Tertiary industry 7.5 9.1 9.1 10.3 11.1 10.2 10.0 10.0
Size of the economy etc
Nominal GDP (US$bn) 469 558 636 733 830 1,076 1,281 1,493 Nominal GDP (INRbn) 24,546 27,546 31,494 35,803 41,458 46,956 53,473 61,114 Nominal GDP (INRbn, % y-y) 7.7 12.2 14.3 13.7 15.8 13.3 13.9 14.3 Population (mn) 1,051 1,068 1,085 1,101 1,118 N/A N/A N/A
GDP per capita (US$) 446 522 587 666 742 N/A N/A N/A
Gross national savings (% GDP) 26.4 29.8 31.8 34.3 34.8 N/A N/A N/A
External indicators
Exports (customs, US$, % y-y) 17.6 22.5 26.2 29.5 22.0 21.1 14.0 15.0 Imports (customs, US$, % y-y) 18.6 27.5 39.0 34.5 26.4 26.5 19.1 19.0 Trade balance (customs, US$bn) (8.9) (13.9) (27.3) (40.8) (56.1) (77.6) (100.0) (125.9) Current account (US$bn) 6.3 14.1 (2.5) (9.2) (11.1) (21.4) (40.5) (46.8) Current account (% GDP) 1.4 2.5 (0.4) (1.3) (1.3) (2.0) (3.2) (3.1) Capital & financial account (% GDP) 2.3 3.0 4.4 3.2 5.4 N/A N/A N/A Inflow of FDI (US$bn) 5.0 4.3 6.1 7.7 19.5 N/A N/A N/A International reserves (US$bn) 72.6 108.8 137.0 145.9 192.4 N/A N/A N/A Import coverage (months) 10.7 13.5 11.2 9.1 9.8 N/A N/A N/A External debt (US$bn) 104.9 111.6 123.2 126.4 155.0 N/A N/A N/A External debt (% GDP) 22.4 20.0 19.4 17.2 18.7 N/A N/A N/A Short-term external debt (% GDP) 1.0 0.8 1.2 1.2 1.5 N/A N/A N/A
Fiscal indicators (% GDP)
Central government expenditure 16.9 17.1 15.9 14.3 14.1 N/A N/A N/A Central government revenue 10.9 12.6 11.9 10.2 10.4 N/A N/A N/A Central government balance (5.9) (4.5) (4.0) (4.1) (3.7) N/A N/A N/A Debt of central gov (INRbn) 15,611 16,696 18,227 19,655 N/A N/A N/A N/A Debt of central gov (% GDP) 69.2 65.6 64.1 61.2 N/A N/A N/A N/A
Money, prices and forex rate
Money supply M3 (fiscal year-end) 14.7 16.8 12.3 21.2 20.7 N/A N/A N/A Loan growth (fiscal year-end) 23.3 17.5 19.7 19.0 21.2 N/A N/A N/A
CPI (average) 4.1 3.8 3.9 4.2 6.8 N/A N/A N/A
WPI (average) 3.4 5.5 6.5 4.4 5.4 4.2 4.9 5.0
Reverse repo rate (average) 5.67 4.70 4.60 5.14 5.88 N/A N/A N/A Reverse repo rate (fiscal year-end) 5.00 4.50 4.75 5.50 6.00 5.75-6.25 5.75-6.25 5.75-6.25 INR:US$1 (average) 48.3 45.8 45.0 44.3 45.2 39.6 38.0 37.0 INR:US$1 (fiscal year-end) 47.5 43.6 43.8 44.6 43.5 38.0-44.0 37.0-42.0 36.0-41.0
Credit ratings (long-term foreign currency, year-end)
S&P BB BB BB BB+ BB+ BBB- N/A N/A
Moody's Ba2 Ba1 Baa3 Baa3 Baa2 Baa3 N/A N/A
Notes: Fiscal years are April through March of the following year, except for external debt figures and credit ratings. Credit ratings for FY07 are as of 28 January, 2008 Source: Central Statistical Organisation, Ministry of Commerce & Industry, Reserve Bank of India, IMF, World Bank and others
Economics | Australia Tom Kenny
Australia
Tom Kenny Exhibit 174. Australia: summary of Nomura forecasts
2004 2005 2006 2007F 2008F 2009F
National account (% y-y, real basis)
GDP 3.9 2.8 2.8 3.9 3.5 3.2
Private consumption 5.9 3.1 2.8 4.0 3.8 3.0 Public consumption 3.9 3.0 3.8 2.8 3.2 2.5 Gross fixed capital formation 8.0 7.9 5.0 8.4 6.6 5.0 Increase in inventory
(contribution to GDP growth rate) (0.2) 0.1 (0.6) 0.2 0.0 0.0 Net exports
(contribution to GDP growth rate) (2.1) (1.9) (1.3) (0.9) (1.3) (0.2) Exports (customs, US$, % y-y) 22.1 19.2 14.6 18.0 8.4 2.7 Imports (customs, US$, % y-y) 23.2 13.5 10.6 18.0 8.4 3.2 Trade balance (customs, US$bn) (17.4) (13.2) (11.0) (9.0) (8.0) (7.0) Current account (customs, US$bn) (40.3) (42.8) (40.6) (48.6) (52.3) (54.6) Current account (% GDP) (6.3) (6.0) (5.6) (5.4) (5.4) (5.5)
CPI (average) 2.3 2.7 3.5 2.3 3.3 2.7
Official cash rate (year-end) 5.25 5.50 6.25 6.75 7.25 6.50 A$1:US$ (year-end) 0.78 0.73 0.79 0.88 0.83 0.80 Source: Nomura Australia, ABS, IRESS, RBA