CRISIL Research cuts 2012-13 GDP growth forecast to 5.5%

Rating agency CRISIL has slashed its forecast for the country's GDP growth this fiscal to 5.5% from 6.5% earlier, citing deficient monsoon and the worsening of the crisis in Eurozone as the major factors. Also, it expects lower foreign capital flows this financial year, and so has lowered its target for the rupee to 53 per US dollar, from 50 to the USD earlier.

Excerpts from the report

▪ CRISIL Research has cut India's real GDP growth forecast for 2012-13 to 5.5% from its earlier forecast of 6.5%. The average WPI inflation forecast has been raised to 8.0% from 7.0% released earlier.

▪ The downward revision in India’s growth forecast factors in the adverse impact of rainfall deficiency (an expected deficiency of 15% for June-September 2012, as per Indian Meteorological Department) and worsening of the Euro zone growth outlook (a revision in 2012 growth forecast to -0.6% by Standard & Poor’s relative to the earlier forecast of 'zero' %).

▪ Despite slowing growth, CRISIL Research has revised up its average WPI inflation forecast for 2012-13 to 8.0% to reflect the adverse impact of deficient monsoon on food inflation.

▪ We now expect the fiscal deficit to worsen to 6.2% of GDP in 2012-13 from our earlier estimate of 5.8%. The increase in the fiscal deficit to GDP ratio largely reflects lower revenue growth as a result of slowing GDP growth. In case of a substantial fiscal stimulus to the economy, the fiscal deficit to GDP ratio could worsen further.

▪ The rupee is now expected to settle around 53 per US$ by March-2013 compared to our earlier forecast of 50 per US$. Given the worsening of the Euro zone economy as well as domestic growth slowdown, we now expect the Indian economy to attract lower foreign capital inflows compared to our earlier estimate.

▪ The revised growth forecast assumes that the stretched fiscal situation will limit the ability of the government to give a generous stimulus to the economy. If it does so, then growth will go up but so will fiscal deficit. Similarly high inflation will tie the hands of the Reserve Bank of India (RBI) in aggressively cutting rates to stimulate the economy.

▪ Swift policy action to solve issues related to mining, land acquisition and speedy clearance of projects can create upside to the growth projection.

After we revised India’s macroeconomic forecast for 2012-13 in June, two key risks to the economy have emerged: First, the deficient monsoon; second, worsening of the Euro zone economic outlook. We now forecast India’s real GDP growth in 2012-13 at 5.5%, a percentage point lower than our June estimate of 6.5%. Our forecast assumes

▪ Monsoon deficiency at 15% for the full south west monsoon season (June-September) as indicated by Indian Meteorological Department (IMD) on August 2, 2012

▪ Euro zone growth in 2012 at -0.6%, which is Standard & Poor's (S&P) revised forecast compared to its earlier forecast of 'zero' %.

The revised growth forecast for India does not take into account any substantial fiscal stimulus that may be provided to the economy to arrest and reverse a growth slowdown. A fiscal stimulus may create some upside to industrial and services growth. Upside to growth can also arise from sorting out policy-related issues in mining and power sectors. In contrast, the key downside risks to the revised growth outlook arise from

▪ Monsoons deficiency of more than 15% for the full season as indicated by IMD. In that case, agricultural production could be hit much harder.

▪ A deeper recession in the Euro zone in 2012 with the region's economy shrinking by 1.0%, which is the worst-case scenario projected for the Euro zone by S&P. This will hurt India’s exports and capital inflows further.

According to the IMD, rainfall for the south-west monsoon season is likely to be around 15% deficient close to 20% deficiency recorded in June-July. Even if there is a partial recovery in rainfall in the coming weeks, an overall deficiency of 15% would imply that 2012-13 will end up as a drought year and will result in a substantially lower sowing not only in the kharif season, but will also adversely influence the rabi crop. As a result, agriculture GDP would not grow this year and would record 'zero' % growth compared to our earlier estimate of 3% under the assumption of normal monsoon.

The rupee’s appreciation against the dollar from current levels to around 53 per US$ by March-end 2013 would be supported by easing of the current account deficit in 2012-13 to nearly 3.1% of GDP, from 3.6% estimated earlier. Lower import growth compared to our earlier assumption, due to a fall in India’s GDP growth as well as softening of international oil prices, would reduce the import bill. Despite a slight worsening of the Euro zone situation, India would continue to remain attractive to foreign investors due to 1) Attractive valuations of Indian equity markets because of the sharp rupee depreciation and correction in equity prices. 2) Over 400 bps growth rate differential that India will maintain with the West, despite growth slowdown. However, given the worsening of global and domestic growth outlook, we now expect the Indian economy to attract less foreign capital inflows than expected earlier. As a result, we now expect rupee to settle around 53 per US$ by March-end 2013 compared to our earlier forecast of Rs 50 per US$.

At the current juncture, both monetary and fiscal policies are constrained to revive growth in the immediate run. The upside risks to inflation and limited ability of lower interest rates in propping up growth implies lower room for monetary loosening. The fiscal policy can create some upside to our projected growth scenario by 1) boosting investment expenditure 2) swift policy action to solve issues related to mining, land acquisition and environmental clearances, and speedy clearance of projects. It will also be critical to raise the administered fuel prices to reduce subsidies and create fiscal room for expenditure related to drought-relief measures. Boosting investor confidence in the government’s resolve to tackle both short-term and long-term challenges to sustain growth, especially demonstrating its ability to push through key reforms related to land, labour, taxation and government expenditure, would hold the key to raising India’s growth prospects over the medium run.