Indian Economy Outlook 2009-10

Indian Economy Outlook 2009-10

Dun & Bradstreet

In the past year, the Indian as well as the global economy has witnessed a very high degree of uncertainty and volatility. While the year began on a reasonably optimistic note - particularly for the Indian economy - sentiment was completely reversed as the year drew to a close. Just to 1 underscore this aspect, the D B Business Optimism Index for 04 2008 fell by over 28% as compared to the previous year, when it had actually risen by as much as 9% in Q42007. At the end of 2007, when we had put down our expectations for the coming year, we had stated talent crunch and the availability of well-trained human resources would be the key theme of the coming year. Of course, that expectation has been completely belied in the past 3-4 months, as news of retrenchment, job cuts and slowdown in hiring across various segments of the Indian economy streams in. This sharp shift underscores the somewhat grey theme of the year gone by, as the global financial crisis turned into a global economic slowdown, impacting the fortunes of the Indian economy along its way.

At Dun & Bradstreet, we have had to revise our forecast of GDP growth for FY09 as many as three times in the past 8 months, which again highlights the sharp and sudden change in the variables that affect and impact the economic environment. As the economy battled with high rates of inflation, followed by strict monetary tightening, liquidity crunch and a deteriorating global economic environment, among others, the outlook for growth considerably worsened.

The outlook for the global economy continues to remain bleak. IMF has estimated that world economic growth will fall to 0.5% in 2009, which is the lowest rate since World War II. The advanced economies are expected to contract by 2 per cent in 2009, while growth in emerging and developing economies is expected to slow sharply from over 6% in 2008 to just a little over 3% in 2009. The global economy is expected to experience gradual recovery in 2010, when growth is estimated at 3%, as the impact of expansionary fiscal and monetary policies starts to set in.

It is inevitable that the fortunes of the Indian economy will be impacted by the growth prospects of the world economy as export demand continues to fall, and external financing becomes progressively constrained. However, there are some inherent strengths within the Indian economy, which have spawned the idea of its 'decoupling' from the global economy. While it is debatable whether economies such as India will remain completely insulated from the negative growth prospects of the global economy, there are some factors that might playa mitigating role in the face of the spreading contagion. The presence of a large domestic population, along with the increase in its per capita income on the back of sustained economic growth over the past few years is expected to provide enough of a demand stimulus to ensure continued economic growth for India. Further, a strong saving and investment rate will contribute towards shortening the length and severity of the current slowdown, and also towards a faster revival, when the economic turnaround sets in.

It has become imperative for businesses to track the economic environment on an ongoing basis when changes come in such a dynamic fashion; when perceptions on where macroeconomic risks lie are so numerous and changing so often; when the immediate business environment becomes so closely linked with events that are largely beyond our immediate control.

Real Sector

From expectations of soft landing to fears of a slowdown

The Indian economy was on a roller coaster ride in 2008. At the beginning of the year, overall sentiment prevalent in the economy was optimistic and backed by healthy balance sheets, companies were ploughing back a portion of their earnings into their business through investments in capacity expansions. Employment scenario was upbeat, though the industry was facing a talent crunch. While the global economic environment started to deteriorate by this time owing to simultaneous turmoil in food, energy and financial sectors, the Indian economy was expected to remain insulated and in the worst-case scenario, was expected to be affected only marginally. The strength of domestic demand was expected to sail India through the crisis; however, increased integration of the Indian economy and its financial markets with the rest of the world ensured that the ripple effect of the global crisis was transmitted to the domestic economy via the trade and finance channels. Consequently, towards the end of 2008, corporate profits started to wither, investment demand started to shrink and the talent crunch situation witnessed during the beginning of the year turned into a talent galore situation owing to dearth in employment opportunities. The economic growth forecasts went through several rounds of revision, and most of these were tilted downwards. Strength of business confidence, which was palpable in the number of IPOs, M&As and private equity deals made till 2007, also took a hit during 2008. The declining trend in the D&B's Business Optimism Index further corroborated the receding business confidence.

The Indian economy registered around 9.0% growth during FY04-FY07 and this growth rate gave rise to hopes of structural shift in economic growth. With such a significant growth, debates on a probable overheating of the Indian economy started somewhere towards the end of 2006. However, owing to a changing dynamics, concerns of overheating (till start of 2008) were replaced with concerns of the Indian economy moving into slowdown towards the end of 2008.

Real GDP, which witnessed substantial moderation during Jan-Dec'08, is one of the key indicators of an economy that is losing steam. During Jan-Dec'08, India's GDP growth averaged 7.4% as compared with 9.2% during the corresponding period of the previous year.

The manufacturing sector's growth slowdown was more pronounced and almost halved to 4.02% during Jan-Dec 08 from 9.9% during Jan-Dec'07, which caused moderation in industrial sector growth at 5.7% during Jan-Dec'08 as compared with 9.4% during Jan-Dec'07.

The significant decline in growth of manufacturing sector is partly attributed to the elevated input costs. Prices of several raw materials such as minerals, basic metal alloys and metal products and chemicals increased substantially during the first nine months of 2008. Input costs were further pushed up by fuel prices, which surged during this time. Manufacturers could not pass on increase in input costs through price rise to customers given the subdued demand conditions. Cement, construction and steel industries, more specifically; witnessed significant moderation in growth, owing to elevated international prices of inputs such as crude oil, coke and coal.

Besides, demand was subdued in real estate and consumer durables sectors on account of high interest rates. The RBI further hiked key policy rates in Jan 2007 amidst rising concerns of overheating of the economy; this high interest rate regime lasted till mid-2008. High interest regime and consequent moderation in retail credit off take caused deceleration in credit-funded consumption demand. As a result, growth in private final consumption expenditure slowed down to 7.0% during Jan-Dec'08 as against 7.9% during the corresponding period of the previous year.

The combined effect of decelerated domestic demand, elevated input costs, and high interest rates was primarily felt by the manufacturing sector, with as many as 14 out of 17 major industry groups witnessing lower growth during Jan-Dec'08. Domestic industrial activity also slowed down as a result of downturn in manufacturing sector as evident from the sharp slowdown in the average growth of Index of Industrial Production (IIP) to 4.2% during Jan-Dec'08 as compared with 9.9% during Jan-Dec 07.

Furthermore, investment demand slowed down in the economy with rising borrowing cost (a result of monetary tightening measures) and weakening business confidence amidst slowing consumption demand. Global liquidity crunch and rising risk aversion among international investors, due to the worsening of global financial crisis in the latter half of 2008, drained the external financing route for the corporate sector. The bearish sentiment in the domestic stock markets due to FII outflows also made it difficult for the corporate sector to raise funds from this avenue. The freezing of external as well as internal mode of financing, coupled with subdued demand conditions has impeded investment growth. This was further reflected in the substantial moderation in growth of 'basic metal and alloy' industries and 'machinery and equipment, other than transport equipment' industries, which pulled down growth in capital goods sector to 8.7% during Jan-Dec'08 from 19.6% during Jan-Dec'07. Further, a significant slowdown in exports (particularly of textiles, leather and fur products, and gems & jewellery) and weak domestic demand conditions curbed production, leading to downsizing of labour in many industries.

The services sector, which has been the key growth driver over the last five years, has also started showing signs of moderation, reflecting the combined impact of elevated fuel prices (till Aug'08), high interest rates, and global economic slowdown. Growth in services sector averaged at 10.2% during Jan-Dec'08 as against 10.4% during Jan-Dec'07.

The RBI took a number of monetary easing and liquidity enhancing measures since Sep 08 to mitigate the impact of the global economic meltdown on the Indian economy. The government also announced a slew of fiscal measures to stimulate demand, which included an additional plan expenditure of up to Rs. 200 bn in the current fiscal, an additional allocation of Rs. 14 bn to clear entire backlog in Technology Upgradation Fund Scheme (TUFS), an across-the-board cut of 4.0% in the ad valorem Cenvat rate, and a 2.0% interest subvention for labour-intensive export sectors.

While these measures are likely to boost demand and support economic growth to a certain extent, one cannot rule out the chances of a marked slowdown in economic activity in the forthcoming quarters. Nevertheless, since the underlying fundamentals of the Indian economy continue to remain strong, D&B expects India to recover faster from the current turmoil.

Outlook for the Indian Economy 2009-10

In the beginning of the current financial year, there was greater optimism about India's growth prospects and D&B believed that the strength of domestic demand, particularly investment, would enable India to achieve a real GDP growth of 8.5% in FY09. While due consideration was given to the financial turmoil being witnessed in the developed economies, India was not expected to be seriously affected by the unfolding crisis. However, since Sep'08, the scale of crisis intensified and its knock-on effects were felt in the real sector. Acute liquidity crunch and decelerated economic activity resulted in pronounced fall in investors' appetite for risk. Developing economies, particularly the ones who relied on exports and on global financial markets for their financing needs also got engulfed in the crisis. Risks to the global growth outlook were significant and tilted firmly towards downside. In such a scenario of changing dynamics of uncertainty, and downside risks to the global economic growth, D&B felt the need to revise India's growth prospects. The cyclical downside risks to growth increased significantly during the last few months of 2008. Therefore, D&B revised its GDP growth forecast downwards to 8.0% in Sep'08 and further to 6.8% in Feb'09. The downward revision is driven largely by the following developments:

▪  Investment demand losing steam

▪  Heightened uncertainty in global markets

▪  Waning consumption demand

▪  Downtrend in industrial production

▪  Slowing services sector growth

▪  Slowdown in savings

▪  Mounting stress on external balance

▪  Uncertainty on employment front.

While D&B is less optimistic about the near-term growth prospects, D&B believes the economy would pick up in the medium to long term period. Consumption demand is expected to receive a boost once the lagged effects of the aggressive policy responses by the Government and the RBI start unfolding. Rise in consumption demand will in turn provide some fillip to industrial production, going forward; however, savings rate will shrink primarily due to erosion in value of physical and financial assets of households and decrease in corporate profitability. The combined impact of lower domestic savings and deferred capital expenditure plans by companies owing to funding pressures will lead to moderation in investment rate in FY10.

On the inflation front, D&B expects WPI inflation to ebb significantly in FY10 as weak consumption demand, significant deceleration in international commodity prices, decrease in input costs and the high base effect come into play. Further, a significant respite is expected on the interest rate front, as it is expected to come down significantly and in turn support demand growth.

On the external front, exports are likely to suffer in the short term and are expected to miss the target set for FY09 by miles due to heightened uncertainty in global markets and substantial slowdown in global demand; however, it is likely to improve during H2 FY10. Stress on external balance is likely to intensify due to mounting trade deficit.

Real GDP to grow by 6.7% in FY10

D&B believes the economy would pick up in the medium to long term period, when lagged effects of aggressive policy response by the Government and the RBI would come into effect completely and some amount of stability is restored in the external environment. D&B believes that the strong fundamentals of the Indian economy are a key to early reversal. D&B expects GDP growth to bottom out during H1 FY10, see a reversal by H2 FY10 and average at 6.7% for FY10.

D&B expects the industrial sector growth to average at 4.6% during FY09, significantly lower than 8.1 % in FY08. Further, on account of improvement in demand during H2 FY10, industrial sector growth is expected to improve and average at 5.5% during FY10. Growth in services sector is also expected to slowdown to single digit level of 9.5% in FY09 mainly owing to poor performance of trade and financial sectors. However, services sector growth is projected to decelerate to 8.3% for FY10 as the lagged effects of slowdown in the industrial sector on services intensify. Though the service sector growth will stagger, it is expected to register the highest growth within the three broad sectors of the economy; as a result, the service sector will retain its importance in GDP and its contribution is expected to increase from 55.7% in FY08 to 58.0% in FY10.

Domestic Consumption to Drive Growth in the Recovery Phase

Consumption demand is likely to be restrained in the near future in view of -

▪  Increasing uncertainty on the employment front

▪  Decline in income growth

▪  Significant slowdown witnessed in labour-intensive sectors, especially SMEs and export, oriented sectors

▪  Significant erosion in value of financial and physical assets.

Declining income growth, negative wealth effect and cautious consumer as well as business sentiments are likely to limit the positive near term impact of the monetary and fiscal measures aimed at stimulating demand. D&B expects the aggregate consumption demand as measured by Private Final Consumption Expenditure (PFCE) to moderate to 6.5% during FY09 as compared with 8.1 % in FY08. However, PFCE is expected to improve slightly to 6.7% in FY10 as fiscal measures and lower interest rates begin to boost confidence and stimulate demand in latter half of FY10.

Industrial production to pick up in H2 FY10

D&B expects growth in industrial production to be around 3.5% during FY09 as compared with 8.5% during FY08. However, industrial production is expected to improve during H2 FY10 and register an average growth of 5.3% during FY10 on account of:


▪	Rise in domestic demand

▪	Stability in export demand

▪	Faster implementation of infrastructure projects that are in pipeline and increase in the developmental expenditure by the Government in FY10.

Savings Rate to Shrink

D&B expects the domestic savings rate to moderate to 33.0% and further to 32.8% during FY09 and FY10 respectively from around 37.7% in FY08. Factors that would weigh down on domestic savings are:

▪  Lower corporate profitability

▪  Significant widening of fiscal deficit

▪  Erosion in value of financial and physical assets.

Investment Rate to Moderate

D&B expects investment rate to moderate to 35.5% in FY09 and further to 35.0% in FY10 from 39.1 % in FY08. Investment rate would be hampered owing to:

▪  Deferment of capital expenditure plans by companies

▪  Lower domestic savings

▪  Funding pressures (as various avenues for funding dry up including bank credit)

Bank Credit to Moderate

D&B forecasts the bank credit growth to moderate to around 21.5% by end of FY09 and then to 20.0% by end of FY10.

D&B expects the momentum in the bank credit growth to slowdown on account of:

▪  Increase in risk aversion of banks

▪  Lower demand for bank credit by industry due to production cuts and deferred investment plans

▪  Deferred consumption of high-end consumer product and lower demand for home loans.

Interest Rates to Lower Significantly

D&B expects Prime Lending Rate (PLR) to soften and stand at 11.75-12.25% by end of FY09. The lending rates are expected to come down further during FY10, as the aggressive monetary easing measures undertaken by the RBI since mid-Sep 08 would have injected sufficient liquidity into the system and would drive down interest rates. Moreover, the decline in inflation rate will provide more flexibility to the RBI to further ease its monetary stance, thereby signalling towards lower interest rate regime. D&B expects the PLR to stands at 10.5-11.0% by end of FY10.

Deflationary Trends to be Observed During Few Weeks of FY10

D&B expects WPI inflation to average at 9.0% for FY09, to move downwards thereafter and to average at around 3.0% during FY1 0 as factors such as weak consumption demand, significant deceleration in international commodity prices (especially crude oil), decrease in input costs (which will induce reduction of final product prices) and the high base effect come into play. D&B also expects to witness a deflationary phase during the first few weeks of Q1 FY10.

Stress on External Balance Likely to Increase

D&B expects exports to be around US$ 178 bn in FY09, which is approximately US$ 22 bn lower than the Government's target, owing to economic downturn witnessed in India's key export markets. D&B, however, expects exports to witness some revival during the second half of FY10, when the world economy begins to stabilise. D&B expects exports to grow around 14% to US$ 203 bn during FY10.

Imports, on the other hand, are expected to be around US$ 300 bn in FY09 and are likely to increase further to US$ 353 bn in FY10, as demand will pick up in the Indian economy during latter part of FY10. Imports are expected to grow at 17.7% during FY1 0, which is lower as compared to 25.0% (estimated) during FY09.

D&B expects the trade deficit to increase to US$ 122 bn in FY09 and further to US$ 150 bn in FY10, as growth in imports is expected to be greater than exports. Further the current account deficit would surge to 2.6% of the GDP in FY09, as trade deficit is expected to be high and is not likely to be offset by higher invisibles receipts (due to lower private transfers as well as lower services exports). D&B expect the current account deficit to be around 2.2% of GDP in FY10 as invisible receipts are expected to pick up once the external environment stabilises by the latter half of FY10.

Rupee to Rally from the Current Levels

D&B forecasts the rupee value to be around 49.5/US$ by the end of FY09. The rupee is expected to appreciate in the next fiscal and to be around 46.5/US$ by the end of FY1 O. On an average, rupee is expected to be around 45.90/ US$ during FY09 and 47.50/US$ during FY10. The appreciation in rupee in next fiscal (towards end) would be on account of an expected fall in value of US dollar and resumption in the FII inflows as the global economy begins to stabilize during the latter part of FY10.

Some Concerns to Growth

With India's increasing integration with the global economy, we remain more susceptible to the volatilities in the world markets for currency, commodity and finance. Our prognosis of the overall economic scenario should therefore be assessed with due consideration being given to certain developments - domestic as well global. One of the key concerns to growth prospects would be an extended global credit crunch. If the stress in global financial markets does not abate by the end of 2009, or if there are other big surprises in terms of financial sector write-downs, key economic activities will be further impacted. In addition to risks related to persistent financial stress, declining consumption in developed economies and the risks of rising protectionism could significantly weigh down our export and this will in turn feed through to limit Indian companies' production and employment. While the upside risks to inflation outlook have diminished lately as commodity prices have retreated from its record highs, any shocks to oil prices (in the event of geo-political tensions and expected cut in oil production by OPEC) could stoke price pressures on crude oil.

In addition to threats stemming from unforeseen developments in the global environment, there are certain domestic concerns as well. Foremost amongst them is the mounting stress on the Centre's fiscal position. There has been a significant growth in expenditure of the Central Government owing to growing off-budget liabilities, enhanced expenditures on subsidies, loan waivers, salaries, infrastructure projects. Moreover, the Government is expected to suffer revenue losses as the economic slowdown takes hold. Cuts in excise and customs duties done to provide relief to the demand constrained economy will significantly lower tax collections. The Government fiscal deficit will therefore be considerably higher than the budget estimate.

The additional government expenditure is likely to place upward pressure on interest rates and has the potential to crowd out private investment, particularly at a time when the economy starts reviving and investment demand begins to increase. Secondly, in the event of poor monsoons, agricultural growth will be impacted to a large extent. Apart from the significant (and lagged) effect on industrial sector performance, the monsoon effect could feed into WPI figures through higher food and primary articles prices.