India: A Very Troubled Scenario...........

Tags: base case, crude prices, diesel prices, dietary preferences, financial losses, food price, food subsidy, INR, invisibles, national food security, oil imports, oil subsidies, overshoot, power utilities, REVERSE REPO, risk appetite, security bill, stickiness, yoy

ags: base case, crude prices, diesel prices, dietary preferences, financial losses, food price, food subsidy, INR, invisibles, national food security, oil imports, oil subsidies, overshoot, power utilities, REVERSE REPO, risk appetite, security bill, stickiness, yoy

Inflation has been a concern for the RBI, which raised its March 2011 inflation estimates by ~250bps over the last quarter from 5.5% to 8%. We expect trends to remain sticky in the ~7.5% range through FY12 due to higher global crude prices, continued stickiness in manufactured non-food products inflation, and structural food price increases due to changing dietary preferences. Our base case factors in the RBI raising rates by 75bps by early 2012, taking the repo/reverse repo rate to 7.50/6.50%, but upside risks to inflation could result in an extension of the monetary tightening cycle.

On the fiscal front, we expect to see an expenditure overshoot of ~Rs500-700bn, which would take the FY12 headline deficit number to 5.3% of GDP vs. the target of 4.6% of GDP. Key risks are (1) higher oil subsidies — assuming no deregulation in diesel prices, oil subsidies are expected to rise to Rs1.4trillion, with the govt’s share pegged at 50% (2) Food subsidy: With the government likely to introduce the National Food Security Bill, we could see an additional outgoing Rs200bn (3) financial losses of State Power Utilities (SPUs) are currently at Rs526bn, or 0.9% of GDP. What’s more concerning is that the 13th Finance Commission estimates losses could mount to Rs686bn in FY11 and further to Rs1.2trn in FY15E.

On the external front, the trade deficit is estimated to widen to US$161bn in FY12 from US$125bn in FY11E; on the back of (a) imports rising 22.5%YoY in FY12 due to a 35% rise in oil imports and (b) exports rising 19%YoY. Coupled with a slight moderation in invisibles, this would result in the CAD coming in at US$61.7bn in FY12 (3.1% of GDP vs. 2.3% in FY11). On the capital account, recent budgetary measures could result in flows remaining strong at US$69.6bn. This could take the overall balance to US$7.9bn vs. US$18.2bn in FY11E. We expect trends in the INR to be range-bound, with key factors influencing movement being (1) risk appetite that would facilitate a move in portfolio flows from EMs to DMs (2) sustained rise in export growth.