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1、,November 1,2012Issue No:12/19Asia Economics AnalystEconomics ResearchIndias reforms:Well begun,but not half doneTushar Poddar,Indias economy has had a tough 2012 with elevated inflation,slowing growth,andwider twin deficits on the fiscal and current accounts.In the near term,a quick,+91(22)6616-904
2、2 Goldman Sachs India SPL,turnaround is unlikely,and we think economic growth is likely to remain belowtrend.Inflation is likely to rise further in the near term.We are revising our WPI forecast upto 7.9%from 7.2%for FY13(April 2012 to March 2013),on the back of an increase inadministered prices(die
3、sel,electricity,coal)and their second-round effects.With near-term inflation remaining above the Reserve Bank of Indias comfort zone,we push back the timing of the next rate cut from December to March,though westill expect a cumulative 50 bp in cuts by 1Q2013.Further,the twin deficitsfiscal and curr
4、ent accountare likely to be a little higherthan we expected earlier.We expect the fiscal deficit for FY13 at 5.6%of GDP(from5.3%of GDP earlier),and the current account deficit at 3.7%of GDP(from 3.5%earlier).Consequently,we are also revising our three-month USD/INR target to 53from 51.5 earlier.Ther
5、e is,however,room for more optimism looking into 2013 due to easier financialconditions and positive confidence effects from the start of economic reforms,in ourview.While reforms have started well,and arguably reduced tail risks for the economy,they need to be sustained in order to lead to a more m
6、eaningful improvement in thebusiness cycle.We will be watching the next session of Parliament(which begins on November 22)closely as a number of important reform bills are likely to be introduced.Investors should consider this report as only a single factor in making their investment decision.For Re
7、g AC certificationand other important disclosures,see the Disclosure Appendix,or go to,The Goldman Sachs Group,Inc.,Goldman Sachs,2,2,November 1,2012,Asia Economics Analyst,Indias reforms:Well begun,but not half doneThe year 2012 has been a tough one for Indias macro economy,characterized by elevate
8、dinflation,high fiscal and current account deficits,a weakening currency,and falling outputgrowth.A weak external environment,domestic policy stasis,and a less-than-normalmonsoon have affected fundamentals(see India:A drought of growth,Asia EconomicsFlash,August 1,2012).Under these challenging circu
9、mstances,the government embarked on a reform programstarting from September 13,which thus far has included opening up to FDI,raisingadministered prices,and restructuring the power sector among others.This has helpedassuage somewhat investor sentiment,led to a significant increase in portfolio inflow
10、s,andeased domestic liquidity conditions.The tail risk of a sovereign downgrade,sharp capitaloutflows,and a more significant depreciation in the INR seems to have been mitigated bythe governments actions.However,there is still little sign of an improvement in theinvestment cycle,in the trajectory of
11、 inflation,or in the trade deficit.This will requirecontinued policy focus and an improvement in external conditions.I.Growthstill weak but likely at a trough on easier liquidityEconomic activity levels remain weak.Our Current Activity Indicator(CAI)(see Exhibit 1)2remains at low levels,despite a sm
12、all uptick in July and August.Investment demand,inparticular,remains very weak as demonstrated by still anemic order inflows and projectstarts.The HSBC/Markit PMI has remained at low levels through the summer.A less-than-normal monsoon is also moderating consumption demand as demonstrated by weak au
13、tosales,among others.Therefore,we see activity remaining weak in 4Q2012.Exhibit 1:Our Current Activity Indicator remains at low levels,quarter on quarterpercentage change,annualized,India CAI&GDP,quarter on quarterpercentage change,annualized,16.014.012.010.08.06.04.02.00.0,India CAI,India GDP ex ag
14、ri(rhs),16.014.012.010.08.06.04.02.00.0,Mar-06,Mar-07,Mar-08,Mar-09,Mar-10,Mar-11,Mar-12,Our Goldman Sachs India Current Activity Indicator(CAI)is the current activity index that maps monthly,sequential real activity from 15 data indicators into one series.Source:CEIC,Bloomberg,Haver,GS Global ECS R
15、esearch.Our India CAI is a current activity index that maps monthly,sequential real activity from 15 dataindicators into one series.Goldman Sachs Global Economics,Commodities and Strategy Research,3,November 1,2012,Exhibit 2:New project starts continue to decline.Average New Project Starts(Industria
16、ls+Infrastructure),Asia Economics Analyst,US$billion100,US$billion100,908070605040302010-,Government,Private,908070605040302010-,Mar-05,Mar-06,Mar-07,Mar-08,Mar-09,Mar-10,Mar-11,Mar-12,Source:CMIE,GS Global ECS Research.Exhibit 3:while growth in projects under implementation has been stagnating,year
17、 on year60%50%40%30%20%10%0%,Growth in Projects under ImplementationSustained slides in projectsunder implementation,followedby stagnation,year on year60%50%40%30%20%10%0%,Mar-05,Mar-06,Mar-07,Mar-08,Mar-09,Mar-10,Mar-11,Mar-12,Source:CMIE,GS Global ECS Research.Activity is likely at a trough,as eas
18、ing financial conditions and liquidity suggesta modest upturn in 1H2013.Liquidity in the banking system and money markets hasimproved considerably after aggressive action by central bank in springtime.Liquiditydeficit spiked up in March 2012 due to fiscal year-end effects and has been improving sinc
19、ethen.Short-term AAA-rated Certificate of Deposit(CD)rates have fallen by 325 bp sinceMarch.The daily borrowing from the repo window of the Reserve Bank of India(RBI)hascome down considerably from a peak of US$37 bn in March to US$10 bn currently.Creditdeposit ratios have also improved,in part due t
20、o weak credit growth.In addition,the onsetof reforms is beginning to turn business confidence,as shown by the latest reading of theRBIs business expectations index.Goldman Sachs Global Economics,Commodities and Strategy Research,4,November 1,2012,Exhibit 4:Liquidity has improved as shown by falling
21、CD rates,Asia Economics Analyst,Percent12.011.010.09.08.0,3-month CD,Certificate of Deposit(CD)Rates6-month CD,12-month CD,Percent12.011.010.09.08.0,Sep-11,Dec-11,Mar-12,Jun-12,Sep-12,Source:Bloomberg,GS Global ECS Research.The recent increase in capital inflows and liquidity injections by the RBI h
22、as helped.TheRBI has done Open Market Operations(OMOs)worth US$32 bn,cut the cash reserve ratio(CRR)of banks by 175 bp,and cut the repo rate by 50 bp in 2012.Capital inflows havebuttressed the domestic easing of liquidity.Since September,portfolio inflows haveincreased by over US$7 bn,with a majorit
23、y through equity inflows.Our Banking Research Team expects that asset quality concerns will likely peak in FY13(April 2012 to March 2013),and not worsen further in FY14(April 2013 to March 2014),based on their analysis of 2,500 manufacturing and service firms(see India:FinancialServices:Stressed ass
24、ets still on the rise,but accretions should moderate in FY14;September 14,2012).In addition,banks have intensified recovery efforts that they believewill show up in numbers over the next few quarters.The liquidity easing should enablebanks to cut rates in order to reduce stress,and could kickstart a
25、 virtuous cycle of greaterfunding availability,lower rates,and moderating stress levels.Our leading indicator of activity,the GS-India Financial Conditions Index(FCI)has eased by136 bp since March-2012,mainly due to short-term rates declining,but also due to aweaker currency.The easier conditions ca
26、n help support domestic activity.In addition,theexpectation of a normal winter crop can shore up consumption demand.Therefore,weexpect an upturn in activity in 1H2013,with GDP growth above 6%yoy,though still belowpotential,which we believe is at around 7%yoy.Goldman Sachs Global Economics,Commoditie
27、s and Strategy Research,3,5,November 1,2012,Exhibit 5:Financial conditions have eased significantly since March,Asia Economics Analyst,Index Jan 1,2001=100929394959697,GS India-FCI:Dailymeans looseningTighteningsinceOctober2009,Index Jan 1,2001=100929394959697,Jul-08,Jan-09,Jul-09,Jan-10,Jul-10,Jan-
28、11,Jul-11,Jan-12,Jul-12,GS India-FCI=100+85%*nominal average interest rate+12%*100*log(NEER)-3%*100*log(SENSEXIndex),where average interest rates is a simple average of the policy repo rate,the 3-month treasury bill and the3-month MIBORSource:Bloomberg,CEIC,GS Global ECS Research.II.Inflation and mo
29、netary policyelevated inflation may not allowaggressive easing by the RBIWe are raising our average FY13 WPI inflation forecast to 7.9%yoy from 7.2%yoy earlier due to upward surprises in inflation.Core inflation came in a worrying7.1%qoq annualized rate in September,significantly higher than its rec
30、ent trough of 2.4%qoq annualized in April.Other indicators of inflation,including the CPI and inflationexpectations remain highly elevated.Inflation expectations have remained in double digitsthrough the year,while the input and output price indices in the PMI have yet to showmeaningful declines.We
31、think that the increase in administered prices and the second-round effects on core willcontinue to keep inflation elevated in FY13(April 2012 to March 2013),with our end-Marchforecast at 7.6%yoy and the average at 7.9%yoy.While there has been some moderationin real wage growth in the rural sector,a
32、nd there may also be some benefits from INRappreciation,3 the pass-through from higher administered prices is yet incomplete:Diesel prices were raised by 12%in mid-September.Eighteen states have increased electricity tariffsthe latest being Uttar Pradesh,Indias largest state,which has raised prices
33、by about 18%.Minimum support prices for food have been raised between 15%-40%this year.Reforms in the coal sector will likely lead to coal price increases in the near future.In addition,the second-round effects of these price increases on core have yet to be fullyfelt.Our sensitivity analysis sugges
34、ts that headline WPI decreases by 60 bp for every 10%INRappreciation.Goldman Sachs Global Economics,Commodities and Strategy Research,6,November 1,2012,Asia Economics AnalystWe see limited room for policy easing by the RBI in the near term due to high andpersistent inflation.We did not expect the RB
35、I to cut rates in October(see Reserve Bank ofIndia keeps repo rate unchanged,against market expectations;cuts CRR by 25 bp,AsiaPolicy Watch,October 30,2012)and we think that the RBI is unlikely to ease in December.Exhibit 6:Inflation likely to peak in DecemberWholesale Price Index,108642,Core(Non-fo
36、od manufactured)(Year on year percentage change)Headline(Year on year percentage change)Core(Quarter on quarter percentage change,annualized)Forecasts,108642,0,Sep-11,Dec-11,Mar-12,Jun-12,Sep-12,Dec-12,Mar-13,0,Source:CEIC,GS Global ECS Research estimates.Exhibit 7:making it unlikely that RBI can ea
37、se until 4QFY13,Percent10,Policy Rates,Percent10,98765432,Reverse RepoCRRRepo,Forecasts,98765432,Mar-04,Mar-05,Mar-06,Mar-07,Mar-08,Mar-09,Mar-10,Mar-11,Mar-12,Mar-13,Mar-14,Source:RBI,GS Global ECS Research estimates.Goldman Sachs Global Economics,Commodities and Strategy Research,7,November 1,2012
38、,Asia Economics Analyst,We now expect the RBI to remain on hold through year-end and to ease by 50 bpin March,2013.We think that the RBI would want to see some evidence of inflationarypressure coming off as well as the governments fiscal consolidation path before cuttingrepo rates.Our forecasts sugg
39、est WPI inflation peaking in December and gradually comingoff thereafter due to the waning away of unfavorable base effects and the diminution of thedirect effects of administrative price increases.With inflation at its peak before the Januarypolicy meeting,the RBI may be more conservative at that m
40、eeting,in our view.Further,thegovernment will present its budget in early March,and signal its intention to adhere to thefiscal consolidation road-map laid out by the Finance Minister.The guidance given by theRBI on October 30,that there was a reasonable likelihood of further policy easing in thefou
41、rth quarter of FY13(April 2012 to March 2013)suggests to us easing in March.Our view of the RBI on hold for longer goes against the recent decisions of central banks inthe region.Recent rate cuts by the Bank of Thailand,Bangko Sentral ng Pilipinas,and theBank of Korea have been in part due to inflat
42、ion remaining comfortable and in part due toconcerns about external balance in the wake of large capital inflows and FX appreciation.Indias inflationary pressures have been stronger than in the rest of the region,while it hasbeen facing FX depreciation pressures.III.The twin deficits remain an overh
43、ang on the economyWe think the central government fiscal deficit will remain high at 5.6%of GDPin FY13(up from our earlier estimate of 5.3%of GDP).Despite the governmentsconsolidation efforts,we think that its revised target announced on October 29 of 5.3%ofGDP will be hard to meet.This is primarily
44、 due to a much higher-than-budgeted subsidyburden,and somewhat lower tax collections than budgeted.Recent reform efforts by thegovernment have actually limited the extent to which the deficit target will be missed.Theincrease in administered diesel prices,and cuts in plan and non-plan expenditure wi
45、ll help.However,there are increasing uncertainties on the amounts that can be gained fromdisinvestment,telecom auctions,and upside risks to spending due to increases in outlayson food and fertilizer subsidies.The government announced a fiscal consolidation path to reduce the central fiscal deficit t
46、o3%of GDP by FY17(April 2016 to March 2017).However,the details of how it will achievethis path are lacking.Structural reforms,such as the introduction of the Goods andServices Tax(GST),further removal of administered prices,and a firm commitment toadhere to annual deficit targets by amending the Fi
47、scal Responsibility Law(FRBMA)will beimportant in this regard.Indias fiscal deficit remains one of the highest in the region,and constrains its ability touse counter-cyclical policy to attenuate the slowdown.The general government deficit,at8%of GDP,is amongst the highest in growth markets and const
48、itutes a key vulnerability.There is not an immediate financing problem,as it funded primarily by domestic banks andpension/insurance funds.However,the high deficit does lead to crowding out andconstrains credit availability to the private sector(see India Union Budget preview:Expectsome fiscal conso
49、lidation,Asia Economics Flash,February 23,2012).Therefore,fiscalconsolidation may be a prerequisite for an upturn in the credit cycle.Concerns of a near-term sovereign ratings downgrade appear exaggerated to us.When S&P had downgraded the outlook to negative in April,they forecast a worseninggrowth-
50、inflation trade-off,high fiscal and current account deficits,and a slow reformprocess.These have played out over the past 6 months roughly in line with S&Ps forecasts.S&P indicated a 1 in 3 chance of a ratings downgrade,to be reviewed over an 18-24 monthperiod.Since the rating agencies take a medium
