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TRANSCRIPT
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CRISILEcoViewJune 2014
GST is the key to fiscal consolidation
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CRISILEcoView
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GDP to grow at 6.0% during 2014-15 assuming normal monsoons.
Partial unclogging of domestic policy logjam and improved global
growth aiding exports, to lift growth. Private consumption demand to
improve marginally, and provide a mild revival in industrial growth.
Downside risk to growth stems from deficient monsoons.
CPI inflation to average 8.0% during 2014-15, lower than 9.5% in
2013-14. Food inflation to moderate as high reservoir levels and
assuming normal monsoons in 2014 increase supply of food articles.
Rate hikes of the previous fiscal to help lower non-food inflation with a
lag.
Current account deficit (CAD) expected to widen to 2.2% of GDP in2014-15 from 1.7% in 2013-14. In 2014-15, import demand to rise as
and when the curbs on gold imports are gradually removed. In
addition, a pick-up in domestic demand to lift investment and
consumption goods imports.
Rupee to settle at 60 per US dollar by March-end 2015, due to a slight
widening of CAD. However monetary easing in the Eurozone, improved
domestic growth prospects and potential opening up of FDI across
sectors will attract higher capital inflows and will cap the fall in the
rupee.
Fiscal deficit for 2014-15 expected at 4.3% of GDP, higher than
governments target of 4.1%. Low probability of adoption of key tax
reforms like goods and services tax to cap the increase in government
revenues. Rollover of fuel subsidies from this year and the Food
Security Bill to limit the downside to subsidies.
10-year g-sec yield to settle around 8.6% by March-end 2015. Higher
than budgeted government borrowings and limited downside to policy
rates during the fiscal to limit the downside to yields.
2012-13 2013-14 2014-15F
Total GDP (y-o-y %) 4.5# 4.7* 6.0
Agriculture 1.4# 4.7* 3.0
Industry 1.0# 0.4* 4.0
Services 7.0# 6.8* 7.6
CPI inflation (%, average) 10.2 9.5 8.0
Fiscal Deficit (% of GDP) 4.9 4.5 4.3
10 year G-sec yield (%, March-end) 8.0 8.8 8.6
Current account deficit (% of GDP) 4.8 1.7 2.2
Rs per $ (March-end) 54.4 60.1 60.0
Note: #Revised estimate, * Provisional estimates
Source: CSO, RBI, Budget documents, Ministry of Finance, CRISILResearch
Economic Outlook
Centre for Economic Research
Dharmakirti Joshi Chief Economist
Vidya Mahambare Principal Economist
Dipti Deshpande Senior Economist
Neha Duggar Saraf Economist
Sakshi Gupta Junior Economist
Anuj Agarwal Economic Analyst
Contact Details
Email: [email protected]
Mumbai: +91(22)33428000
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i
Sections
Overview 1
Roadmap to fiscal consolidation 3
GDP 15
BOP 18
Industrial Production 20
External Sector 24
Inflation 26
Money and Banking 28
Currency 32
Debt 34
Equity 37
Global Economy 39
Index
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Union Budget: Litmus test for future of Indias fiscal healthThe need for fiscal consolidation in India cannot be overstated. Initiating the process of durable correction is, therefore,
one of the foremost tasks before the new government and its ability and willingness to do so will be tested in early July
when it presents the Union Budget for 2014-15. The decisive election mandate has created an enabling environment to
take hard decisions to put Indias public finances on a sustainable path.
Fiscal correction during periods of economic downturn is always difficult and requires hard decisions revenues dry up
while there is pressure to raise spending to boost economic activity. The growth outlook for 2014-15, even after two
years of sub-5% growth, is muted. In the event of monsoon failure, Indias growth will be around 5.2% this fiscal and
not the CRISIL-predicted 6%, making fiscal correction harder to achieve.
With all these limitations, fiscal deficit is likely to stay high at 4.3% of GDP in fiscal 2015 in the base case. Efforts by
the new government to improve tax collections by widening tax coverage, improving compliance and fast-tracking PSUdivestments, and tightening expenditure could create some upside to our forecast.
On the downside, fiscal deficit could widen to 4.5% of GDP in the event of monsoon failure (the latest projection from
the met department is 70% chance of El Nino) as expenditure will rise on account of relief packages for farmers and the
poor.
What is the way out?
That the government will have to exercise restraint on spending and cut subsidies is a given. The previous two Union
Budgets did initiate subsidy cuts, but fiscal deficit reduction was primarily achieved by cutting productive spending.
This kind of fiscal consolidation has not only compounded the effects of already slowing GDP growth in the past few
years, but is also likely to have an adverse impact on the economys long-term growth potential.
Even as work continues on a new fiscal responsibility bill to ensure durable fiscal correction, it is critical to
simultaneously introduce growth- and revenue-enhancing measures such as the long-pending goods and services tax
(GST). This, via improvement in efficiency in the economy, will provide a lift to growth.
Our computations show that implementation of GST could significantly improve tax compliance and provide a direct
boost to tax revenues over the medium run. At the same time, it will have an indirect impact on tax collections via
higher GDP growth over the medium term. Implementation of GST will pave the way for durable fiscal correction.
Even if GST is partially implemented (keeping petroleum products out of its ambit), the fiscal deficit could narrow to
3.3% of GDP by 2016-17. On the other hand, non-implement ation of GST will keep fiscal deficit around 4.2% of GDP
over the next two fiscals. In that case, faster fiscal correction will have to rely on very aggressive PSU stake sale
and/or steep expenditure cuts.
The tone of monetary policy turned a bit dovish in the June policy but maintaining fiscal discipline will be a critical
factor for creating conditions for a rate cut. The forthcoming Union Budget will be a litmus test on this count. In addition
to swift action by the government to tame food inflation, commitment to fiscal discipline will provide the RBI the elbow
room for a pro-growth monetary stance.
Dharmakirti Joshi
Chief Economist, CRISIL
June 2014
Overview
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Key messages
Implementation of Goods and Services Tax (GST) is key to fiscal consolidation. Even a partial implementation of
GST-one that excludes petroleum products- can reduce India's fiscal deficit to 3.3% of GDP by fiscal 2017. The
benefits multiply with the full implementation of GST and fiscal deficit drops to 3.0% of GDP. In its absence, fiscal
deficit would average 4.0% to 4.2% of GDP in fiscals 2016 and 2017.
In recent years, India's debt-to-GDP ratio has stabilized at around 48% of GDP despite a slowing GDP growth rate
and a high fiscal deficit. This is largely due to a beneficial impact of high inflation. If not for high inflation since fiscal
2009, India's debt ratio would instead have risen to 55% of GDP by fiscal 2014.
We forecast India's debt-to-GDP ratio to decline to 45% of GDP by fiscal 2017. As inflation is likely to moderate, and
there is limited upside to growth in the medium term, fiscal consolidation via tax reforms such as GST, rather than
curbs on productive expenditure, will be critical for lowering the debt-to-GDP ratio.
While it might be difficult to cut overall expenditure, the new government should aim to alter the expenditure mix in
favor of productive expenditure. This will help raise India's growth potential in the coming years.
India's fiscal deficit has hovered over 4.5% of GDP in the last three years - glaring deviation from the target of 3%
envisioned in the Fiscal Responsibility and Budget Management Act. Falling revenues in the post crisis years have
made it harder for the government to lower fiscal deficit despite restraining expenditure. In the aftermath of the global
financial crisis, expenditures had risen to 15.6% of GDP (fiscals 2009 to 2011). However, it has been cut back sharply
since then, and is almost near pre-crisis levels (see chart below) - although the quality of expenditure compression is
questionable.
The share of revenues in GDP, though, continues to decline despite one-off gains from disinvestments and spectrum
auctions, and structural tax reforms such as widening of the service tax net. In fiscal 2014, revenues stood at 9.3% of
GDP, down from a peak of 11.7% in fiscal 2008. Had the share of revenues in GDP also returned to its pre-crisis level,
the fiscal deficit would have been under 4% in each of the last three years.
Central government Revenues and expenditures
10.6
9.9
9.0
13.9
15.6
14.1
2005-06 to 2007-08 2008-09 to 2010-11 2011-12 to 2013-14
Revenues (as a % of GDP) Expenditures (as a % of GDP)
Source: Budget Documents, CRISIL Research
GST is the key to fiscal consolidation
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Against this backdrop of revenue and expenditure trends, the task of fiscal consolidation for this government will not be
easy, as there is limited scope for any further expenditure compression. The government will instead have to rely on
raising revenues through structural tax reforms such as GST. By simplifying the tax regime (removing double taxation),
GST could significantly improve tax compliance and provide a direct boost to tax revenues. At the same time, it will have
an indirect impact on tax collections via higher GDP growth.
Given that a full scale implementation of GST in 2014 is unlikely, and there are large roll-over of subsidies from last
fiscal, we forecast that fiscal deficit will stay high at 4.3% of GDP in fiscal 2015. Beyond that fiscal consolidation will
depend on the timing and scale of GST that is implemented.
In the base case, we expect only a partial GST - one that excludes petroleum goods - given the ongoing disagreements
between states and Centre on tax sharing. In this scenario, fiscal deficit is forecast to gradually decline to 3.3% of GDP
by fiscal 2017.
Fiscal deficit
3.9 4.0
3.3
2.5
6.06.5
4.8
5.7
4.94.5
4.3
3.8
3.3
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14RE
2014-15F
2015-16F
2016-17F
As a % of GDP
Note: RE: Revised Estimate; F: CRISIL forecast
Source: Budget documents, CRISIL Research
Fiscal deficit to stay high at 4.3% of GDP in fiscal 2015
In the absence of GST in 2014, the immediate upside to growth in tax revenues will be limited. Historically, tax buoyancy
or the responsiveness (elasticity) of tax collections to changes in GDP is seen to improve with higher GDP growth (refer
to Box 1). However, such improvements are mild unless accompanied by changes in tax rates or significant improvement
in tax coverage.
Based on the historical relationship between tax buoyancy and GDP growth, we estimate that at 6.0% GDP growth in
fiscal 2015, tax buoyancy will be capped at 1. A lift in tax buoyancy through a one-time tax surcharge like last fiscal or
even an increase in tax rates is unlikely (and not recommended) as it could hurt an already fragile recovery. Therefore,
unless there are large gains through disinvestments or spectrum auctions, revenues as a share of GDP are unlikely to
rise significantly in fiscal 2015.
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At the same time, the pressure on expenditure will be high, as there has been large roll-over in subsidies from last fiscal -
estimated at Rs. 670 billion or 25% of recognized subsidies last year. While some part of subsidy accruals might get
rolled over yet again, the new government is unlikely to cut back sharply on capital expenditure in the very first year of its
tenure, as these have already been considerably trimmed in the last three years, and further reductions will severely hurt
growth.
With all these limitations, fiscal deficit is likely to stay high at 4.3% of GDP in fiscal 2015. Efforts by the new government
to improve tax collections without raising rates, but instead by widening tax coverage or improving compliance could
create some upside to our forecast.
On the downside, fiscal deficit could widen to 4.5% of GDP in the event of a monsoon failure. In this scenario, we
forecast GDP growth to slip to 5.2% of GDP and tax buoyancy at the lower growth to decline to 0.9. Expenditures,
particularly fertilizer subsidies, are also likely to be higher than in the base case. The government may also give farm
loan waivers which could further strain the fiscal deficit.
Fiscal deficit to fall to 3.3% of GDP by fiscal 2017 in base case
Forecast for fiscal deficit (with partial GST implementation by early 2015)
2013-14 2015-16F 2016-17F
Actual Bas e cas e M ons oon Failure Bas e cas e Bas e cas e
Tax buoyancy* 0.8 1.0 0.9 1.4 1.4
GDP grow th 4.7 6.0 5.2 6.3 6.5
Revenue(As a % of GDP) 9.3 9.4 9.3 9.7 10.1
Expenditure(As a % of GDP) 13.8 13.6 13.7 13.4 13.4
Fiscal deficit (As a % of GDP) 4.5 4.3 4.5 3.8 3.3
Revenue deficit(As a % of GDP) 3.2 2.8 3.0 1.9 0.8
2014-15F
Note: *Tax buoyancy=% increase in tax revenues for every 1% increase in GDP
Source: Budget documents, CRISIL Research
The road beyond fiscal 2015 will depend on the government's ability to successfully implement GST. The impact of GST
on tax collections will be two-fold.
First, GST will lift GDP growth and increase the tax revenues. By replacing multiple state and central taxes by a single
unified tax, GST will help reduce costs through elimination of double taxation, boost business profitability and attract
more investments. Lower costs will also boost the price competitiveness of India's manufacturing exports and lift export
growth. According to a study by NCAER, a complete implemetation of the GST could lift GDP growth by 0.9-1.7
percentage points for all future years.
Second, higher GDP growth and an improvement in tax compliance due to a simplified tax regime will help lift tax
buoyancy, providing a further boost to tax collections.
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Despite its advantages, we do not envision full-scale implementation of GST by early 2015. The most likely outcome in
our view is only a partial GST - one that excludes petroleum goods given its large impact on state tax revenues. Even
with this, GDP growth is forecast to average 6.4% in the next two years, enabling a gradual correction in fiscal deficit to
3.3% by fiscal 2017. Our base case forecast is based on the following assumptions:
Implementation of a partial GST to begin by fiscal 2015
Continued recovery in GDP growth; growth to average 6.4% over the next two years (fiscals 2016 and 2017),
Efforts by the new government to improve tax compliance and widen coverage; this will provide a further lift to tax
buoyancy,
Reduction in unproductive spending such as subsidies to be offset by an increase in productive spending (capital
expenditure) on infrastructure, health, education, etc for reviving the long-term growth potential of the economy
Disinvestments and non-tax revenues to remain consistent with past five-year trends.
If the government does not raise productive spending as envisaged, or if there are disproportionate gains from
disinvestments and spectrum sales in any given year, it could result in a faster consolidation than what is laid out in this
report. However, such a correction will only be temporary. The government should instead aim for gradual and durable
correction in the fiscal deficit over the medium term.
Impact of GST on fiscal consolidation
With and without GST
(2015-16 to 2016-17) Average GDP growth (%) Average tax buoyancy Average Fiscal deficit (% of GDP)
Full GST 7.0 1.6 3.0-3.3
Base Case: Partial GST 6.4 1.4 3.5
No GST 5.7 1.0 4.0-4.2
Impact of GST 1.3* 0.6 0.7-1.2
Note:* According to NCAER, GST will lift GDP growth by 0.9-1.7 percentage points for every year in the future.
The median of this range has been assumed in our analysis.
Source: Budget documents, Central Statistical Office (CSO), CRISIL Research
Failure to push through GST even in fiscal 2015 will make fiscal consolidation in the medium term more challenging. Tax
revenues would be lower not just because of the direct impact of GST on tax collections but also because of the indirect
impact of slower GDP growth on tax buoyancy. Notwithstanding any reductions in expenditure, lower revenues in the
absence of GST will raise fiscal deficit by 50-70 bps on average in fiscals 2016 and 2017 as compared to the base case
scenario.
In contrast, a full-scale implementation of GST could lift GDP growth to an average 7% in fiscals 2016-2017. The
cumulative impact of higher growth and improved tax compliance in this scenario could lower fiscal deficit to 3.0-3.3%
over the next two fiscals, assuming expenditures remain unchanged from the base case scenario.
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Box 1
Tax buoyancy and GDP growth
Why revenues share in GDP has fallen in recent years?
Revenues, as a share of GDP, have fallen sharply to 9.0% in the recent slowdown, from a peak of 11.7% in fiscal 2008.
Slower growth in revenues, particularly tax collections, in a slowing economy is not unusual. However, in Indias case,
revenues have fallen much faster than GDP as the responsiveness of tax collections to increases in GDP and tax rates -
what is technically called tax buoyancy - has deteriorated significantly in the recent slowdown.
As illustrated in the following chart, tax buoyancy fell sharply during the crisis years (fiscals 2009 and 2010) and has
revived only partially since then despite rolling back the tax concessions that were administered during the crisis years.
In fact, in fiscal 2014, the tax buoyancy fell to 0.8 despite a one-time tax surcharge on high income earners. In other
words, a 1% increase in GDP is currently yielding less than 1% growth in tax revenues. Going ahead, in order to raise
tax revenues as a share of GDP, it will be critical to lift tax buoyancy above 1.
Tax buoyancy 3MMA
1.0
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
1983-84
1984-85
1985-86
1986-87
1987-88
1988-89
1989-90
1990-91
1991-92
1992-93
1993-94
1994-95
1995-96
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
3MMA: 3-month moving average
Source: Budget documents, CRISIL Research
Tax buoyancy rises with GDP growthHistorically, tax buoyancy has risen with higher GDP growth as corporate profits and individual incomes rise more than
proportionately when the economy is growing fast. Also, it is easier to hike tax rates, introduce new taxes or expand the
coverage during high growth years than during a slowdown, providing a further boost to tax collections. As the economy
slows, governments tend to reduce tax rates - usually indirect taxes - in order to support growth. This has a
contractionary impact on tax collections, and reduces tax buoyancy.
Continued
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continued
The figure below shows a positive linear relationship between tax buoyancy (five-year moving average) and GDP growth
(five-year moving average) for fiscals 1992-2014.
Tax buoyancy rises with higher GDP growth
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
4.5 5.0 5.5 6.0 6.5 7.0 7.5 8.0 8.5 9.0 9.5
T
axbuoyancy(5-yearMA)
(5-Year MA)
Source: Budget documents, CRISIL Research
Although tax buoyancy rises with higher GDP growth, such improvements are mild. To structurally lift tax buoyancy
above 1, tax reforms such as GST and measures to improve tax compliance and tax coverage will be key.
What explains trends in India's debt burden - inflation vs fiscal consolidation
The change in a country's debt ratio depends on the evolution of its primary deficit (fiscal deficit prior to deducting
interest payments), its current debt levels, and the differential between its interest cost and nominal GDP growth.
Broadly, a low primary deficit and a large differential between nominal GDP growth and interest rates cause the debt
ratio to decline.
Progress on fiscal consolidation, as envisaged in our base case scenario, will lower India's debt-to-GDP ratio to 45% of
GDP by fiscal 2017 from 48.2% in fiscal 2014.
Debt ratio to decline by fiscal 2017Year 2010-11 2011-12 2012-13 2013-14 By 2016-17
Interest rate (Weighted average borrow ing cost) 7.92 8.52 8.36 8.41** 8.5-9.0*
Debt ratio (Debt as a % of GDP) 48.6 48.1 48.1 48.2 45.0
Note: * Average borrowing costs for fiscals 2015 to 2017, ** April-December 2013
Source: Reserve Bank of India (RBI), CSO, CRISIL Research
The decline will be led by a steady reduction in primary deficit to under 0.5% of GDP by fiscal 2017 from 1.2% currently,
as revenues rise faster with higher GDP growth and partial implementation of GST. A rise in nominal GDP
(denominator), driven by economic recovery, will further aid the decline in India's debt ratio (debt-to-GDP). In the base
case, we expect nominal GDP to rise to 13.0-13.5 % during fiscals 2015-2017 from 12.3% in fiscal 2014 as real GDP
growth picks up.
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Moderation in inflation, albeit limited, will help to keep a cap on the weighted average borrowing cost of the government
in the coming years.
In the table above, India's debt ratio has been simulated for a range of borrowing costs for the government, using the
simple debt dynamics identity (refer to Box 2 for details).
The (un) intended consequences of inflation
India's debt ratio (internal liabilities as a % of GDP)
48.2
40.0
45.0
50.0
55.0
60.0
65.0
1996-97
1997-98
1998-99
1999-00
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
% of GDP
Source: RBI, CSO, CRISIL Research
India' debt ratio, which had been rising steadily since fiscal 1997, peaked at close to 60% of GDP in fiscal 2005, andstarted declining thereafter. However, the declining trend in recent years has been driven more by high inflation, rather
than improving fundamentals such as higher GDP growth (in real terms) or lower fiscal deficit. Moreover, with growth
slowing down sharply and inflation beginning to moderate in the last two years, the decline has been arrested and India's
debt ratio has started to stabilize at around 48% of GDP.
During the high growth years from fiscals 2005-2008, India primary balance (fiscal balance prior to deducting interest
payments) was in surplus. The economy grew at an average 8.9% and its rising growth and improving finances fostered
a sharp decline in its average borrowing costs to 7.4% from 10.3% in the preceding eight years. The differential between
growth (in nominal terms) and interest rates rose sharply, and India's debt ratio declined.
Growth, interest cost and inflation trendsReal GDP
growth
(%)
Nominal
GDP
growth (%)
Inflation
(CPI
based)*
Weighted
average cost of
borrowing
Primary
Deficit
(% of GDP)
Debt/GDP -
start of
period (%)
Debt/GDP -
end of
per iod (%)
1996-97 to 2003-04 6.1 11.1 6.1 10.3 1.00 43.8 59.5
2004-05 to 2007-08 8.9 15.1 5.3 7.4 -0.18 59.6 54.6
2008-09 to 2011-12 7.7 16.0 10.1 7.8 2.56 53.9 48.1
2012-13 to 2013-14 4.6 12.3 9.8 8.4 1.45 48.1 48.2
Note: * CPI IW until fiscal 2012. CPI-combined for fiscal 2013 and 2014.
Source: Budget Documents, CSO, RBI, CRISIL Research
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The situation, however, changed after the global financial crisis (fiscals 2009-2012). India's debt-to-GDP ratio continued
to decline, but not for the right reasons. GDP growth (in real terms) slowed down to 7.7% during fiscals 2009-2012 from
close to 9% during the high growth period. Fiscal consolidation too got derailed. Huge stimulus by the government to
prop up growth and falling revenues pushed India's primary deficit up to an average of 2.6%. However, the differential
between growth (nominal) and interest costs continued to widen to 8.1% from 7.7% as high inflation and fiscal stimulus
pushed up the nominal GDP growth while interest costs hardly rose despite higher inflation. In fact, real interest cost
[borrowing cost adjusted for consumer price index (CPI) inflation] for the government fell to negative 2.2% on average
during fiscal 2009-2012 from positive 2.1% during the high growth years.
One reason for this anomaly could be requirements such as statutory liquidity ratio (SLR) - that mandates financial
institutions to invest a proportion of their liabilities (23% currently) into government bonds - thereby artificially suppressing
the cost of borrowing for the government. Liquidity easing through open market operations (purchase of government
bonds in this context) by the Reserve Bank of India and low credit demand in recent years also helped to keep interest
costs low for the government.
Had inflation not risen so fast since fiscal 2009, India's debt ratio would have risen to 55% of GDP by fiscal 2014 instead
of stabilizing at 48.2% of GDP.
Growth and inflation dynamics
6.1
8.9
7.7
4.66.1
5.3
10.19.8
4
5
6
7
8
9
10
11
12
1996-97 to 2003-04 2004-05 to 2007-08 2008-09 to 2011-12 2012-13 to 2013-14
%, y-o-y
GDP growth CPI Inflation Source: RBI, CSO
In the last two years (fiscal 2013 and 2014), slowing GDP growth (in real terms) and rising borrowing costs have led to a
narrowing of the differential between growth and interest rates to 3.9%. As a result, despite a moderate correction in
primary deficit, the downward trend in India's debt ratio has stalled.
Going ahead, with inflation set to moderate and growth likely to remain capped at 7%, the debt trajectory will depend
largely on the new government's ability to lower its primary deficit. Fiscal consolidation will, therefore, be key for
lowering India's debt ratio in the coming years.
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Box 2
Simple debt dynamics identity
Why revenues share in GDP has fallen in recent years?
The behaviour of Indias debt ratio can be explained by using the simple debt dynamics identity.
ratiodebt/GDPstableagives)(*
GDPnominalingrowthg
rateinteresti
deficitprimaryPDwhere
)(*
1
**
1
giGDP
Debt
GDP
PD
giGDP
Debt
GDP
PD
GDP
Debt
t
t
t
t
tt
=
=
=
=
+
=
Debt dynamics identity
Nominal GDP
growth (%)
Weighted
average cost
of borrowing
(%)
Actual Primary
Deficit (% of GDP)
Primary deficit
(% of GDP)
required for
stable Debt/GDP
ratio (%)
Change in
Debt/GDP ratio
(%)
1996-97 to 2003-04 11.1 10.3 1.00 0.38 15.7
2004-05 to 2007-08 15.1 7.4 -0.18 3.94 -5.0
2008-09 to 2011-12 16.0 7.8 2.56 3.64 -5.8
Source: RBI, CSO, Budget documents, CRISIL Research
Between fiscals 1997-2004, high cost of borrowing and relatively weak GDP growth (average 6.1% in real terms) meant
that primary deficit higher than 0.38% of GDP would cause the debt ratio to rise. As the actual primary deficit during
these years was much higher, averaging 1.0% of GDP, Indias debt ratio rose by 15.7% of GDP.
During fiscals 2005-2008, widening differential between interest rates and growth meant that Indias debt ratio would
continue to decline as long as the countrys primary deficit was less than 3.9% of GDP. In contrast, during these years,
India had a primary surplus of 0.18% of GDP as a result of its strong commitment to fiscal consolidation. Consequently,
Indias debt ratio declined sharply by fiscal 2008.
Between fiscal 2009 and 2012, Indias primary deficit widened to 2.6% of GDP as a result of slowing revenues and fiscal
stimulus administered by the government. However, the primary deficit was still lower than the threshold of 3.6% of GDP
required for a stable debt ratio. Consequently, Indias debt-to-GDP continued to decline.
Quality of fiscal consolidation is a must-watch
While it is true that the next government must bring down fiscal deficit, the path to consolidation is a must-watch. The
new government must focus on achieving a durable and sustained correction in the fiscal deficit, achieved through tax
reforms, rather than by cutting back on productive spending - as has been done in the recent past.
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In the last three years, the government has been aggressively cutting back on expenditures, particularly productive
spending (Centre's plan + unplanned capital expenditure + the revenue grants it gives for capital creation) in order to
meet - even beat - its fiscal deficit targets. Between fiscal 2012 and 2014, as revenues fell short of budgeted levels, the
government cumulatively cut its productive spending by over Rs. 1.4 trillion compared to budgeted levels. Moreover,
most of this reduction took place in critical areas such as health, education, energy and industry.
Actual vs budgeted revenues and expenditures
Rs crore unless specified 2010-11 2011-12 2012-13 2013-14
Budgeted f iscal deficit (As a % of GDP) 5.5 4.6 5.1 4.8
Actual Fiscal deficit (As a % of GDP) 4.9 5.7 4.9 4.5
Budgeted Revenue 727,341 844,912 977,335 1,122,798
Actual Revenue 823,737 788,375 919,770 1,055,336
Shortf all in revenue (- indicates Actual > Budgeted) -96,396 56,537 57,565 67,462
Budgeted Expenditure 1,108,749 1,257,729 1,490,925 1,665,297
Actual Expenditure 1,197,328 1,304,365 1,410,367 1,563,485
Cut in expenditure (- indicates Actual > Budgeted) -88,579 -46,636 80,558 101,812
Cut in produc tive expenditure -63,000 13,575 65,254 ~65,000
Cut in other expenditure -25,579 -60,211 15,304 ~36,812
Source: Budget documents, CRISIL Research
A reduction in productive expenditure is undesirable from a growth perspective. Such consolidation has not only added to
the already slowing GDP growth of the economy in the past few years, but is also likely to have an adverse impact on thelong-term growth potential of the economy.
The next government must not resort to such math. For sustainable growth, the government must raise capital
investments in physical infrastructure and increase spending on health, education, etc to improve the productivity of
labour.
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Sectors which saw expenditure cropping
0.0
2.0
4.0
6.0
8.0
Irrigation andFlood Control
Agricultureand AlliedActivities
RuralDevelopment
Industry andMinerals
Transport Energy SocialServices*
(Rs trillion)FY11 to FY14 cumulative
Budgeted* Actual
Note: Budgeted* includes government spending using extra budgetary resources
Source: Budget documents, CRISIL Research
To create space for such productive spending, the government will have to reduce subsidies - mainly on fuels such as
kerosene and liquefied petroleum gas - and gradually switch its expenditures toward health, education, etc. Currently,
subsidies and interest together account for 40% of total government expenditures - twice the productive spending.
Expenditure switching will have to be supplemented with key tax reforms such as GST which will help raise tax revenuesand fund the higher capital spending. In addition to GST, the government will also have to improve tax compliance and
widen the tax base to raise revenues.
High level of spending on subsidies as compared to productive spending
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
2010-11 2011-12 2012-13 2013-14 2014-15BE
(Rs trillion)
Productive spending Subsidies
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Conclusion
The task of fiscal consolidation for this government will not be easy. There is very little scope to cut overall expenditure,
as it has already been trimmed sharply in the last three years. The government must instead focus on switching from
unproductive subsidies toward spending on sectors such as health, education and infrastructure. The only way to reduce
fiscal deficit, therefore, is to raise revenues as a share of GDP. To do so, the government must implement structural tax
reforms such as GST, improve tax compliance and widen the tax coverage.
The scope to lower fiscal deficit as early as fiscal 2015 is limited given large roll-over of subsidies from last fiscal. Beyond
that, however, implementation of GST could facilitate a much needed correction in fiscal deficit. In the base case, we
believe that partial GST - one that excludes petroleum goods - is most likely. Even with this, fiscal deficit could correct to
3.3% of GDP by fiscal 2017. On the downside, a complete failure to implement GST would result in the fiscal deficit
being higher by 50-70 bps as compared to the base case scenario.
Fiscal consolidation is also critical for lowering India's debt-to-GDP ratio, which has stabilised in the last two years, after
declining steadily since fiscal 2005. From fiscal 2009, however, high inflation has been the primary driver of India's
declining debt-to-GDP ratio. Had inflation not risen so sharply, India's debt ratio would have started rising by now. Going
ahead, as inflation is expected to moderate and the upside to growth will be limited, a strong commitment to fiscal
consolidation will be key to lowering India's debt-to-GDP ratio.
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Revival on cards; GDP likely to grow by 6% in 2014-15
India's GDP growth for 2013-14 came in at 4.7%. This is lower than the government's advance estimate of 4.9% growth
and only slightly better than the 4.5% recorded in 2012-13. Growth in the industry and services segments failed to revive
in the fourth quarter of 2013-14, and GDP growth was in fact lower in the second half of 2013-14 at 4.6%, as compared
to 4.9% in the first half of 2013-14.
The financial / business services and agriculture segments drove growth in 2013-14 while manufacturing remained a
laggard. Of late, there has also been an uptick in mining and utilities (owing to higher electricity production). On the
demand side, a fall in imports along with a pick-up in exports benefited the net export position of the country. Net exportscontributed to more than half of GDP growth in 2013-14.
The decisive mandate in the recent general elections bolstered investor confidence and raised expectations of fast-
paced decision-making and economic reforms. Ensuring sustained growth will, however, require much more substantial
moves. The government's top priority should be to revive the economy by improving the business climate (by
swiftly resolving issues bedeviling iron ore and coal mining, among others) and revive the investment pipeline through
greater clarity on land acquisition and speedier environmental clearances. To improve and fulfill India's long-term growth
potential, it is equally imperative for the government to exercise fiscal discipline, lower inflation, improve banks' asset
quality and revive the manufacturing sector. Some of these steps can revive sentiments in the short term but will
significantly boost growth in the medium term.
Manufacturing, trade drag down overall GDP
-10
0
10
20
30
40
50
60
Financing, insurance,real estate and
business services
Community, Socialand Personal
Services
Agriculture Trade, hotels,transport and
communication
Manufacturing
% contribution to GDP gro wth
FY12 FY13 FY14
Source: Central Statistical Office (CSO), CRISIL Research
GDP
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Where is growth looking up?
Agriculture:Robust monsoons pushed up agriculture growth to 4.7% in 2013-14; total food-grain production rose by
nearly 3%. However, current climate forecasts indicate an increased likelihood of a deficient monsoons in 2014-15
that could affect agriculture production.
Financial, insurance, real estate and business services:This sector contributed more than half of GDP growth in 2013-
14, although, in terms of size, it only had a 20% share. This segment grew by 13% on the back of a rise in business
services exports and a pick-up in bank deposit and lending activities in the second half of 2013-14 (following a surge
in non-resident deposits). Improving global prospects could continue to favour this sector in 2014-15.
Electricity:Electricity generation rose to 961.5 billion units (BU) in 2013-14 from 907.2 BU in 2012-13 mainly on
account of capacity additions (nearly 38 Giga Watts(GW)) over the past 2 years. CRISIL Research expects
electricity production to grow by 4-5% in 2014-15 due to capacity additions (around 11 GW) as well as a marginal
increase in plant load factors led by an improvement in coal supply.
Mining: Mining output fell by 0.8% in the second half of 2013-14 as compared to a 2% fall in the first half. Growth in
this sector has gathered pace in recent months. Mining output is expected to pick up in the coming quarters as
the ban on mining in Karnataka and Goa is lifted. Prior to the mining ban, these two states accounted for 4-5% of the
country's mining output. Mining ban issues in other major states with significant mining output share -- Andhra
Pradesh and Chhattisgarh (about 13% share in mining output each), Odisha (10%), and Gujarat and Madhya
Pradesh (about 8% each) are still awaiting resolution. Fast-tracking decisions in this sector will immensely benefit
these states and improve the overall availability of mineral resources.
Net exports:A 2.5% fall in imports and an 8.4% growth in exports improved the net export position and contributed
54% to overall GDP growth in 2013-14. Although the continued global recovery will support the growth in exports,
net exports could decline in 2014-15 as imports will pick up gradually in line with domestic growth.
Where is growth still lagging?
Trade, hotels, transport and communication:Accounting for nearly 27% of the economy, these sectors are almost
entirely driven by private sector demand. They have been facing the wrath of declining consumption and investment
demand as well as the spillover effects of sulking industrial growth. In 2013-14, these sectors grew by 3% as
compared to a 5.1% rise in 2012-13. However, growth revived slightly in the second half of 2013-14.
Manufacturing:The sector, which has a 16% share in the GDP, continued to suffer as output fell by 0.7% in 2013-14.
The impact of weak domestic demand outweighed any benefits from rising exports. Private consumption growth was
higher in the the second half of 2013-14, possibly reflecting better farm incomes, but full-year growth dropped to
4.8%. High inflation and weak income prospects dented consumer sentiments. Growth in investments also fell by
0.4% in the second half of 2013-14 and remained flat for the full year. The investment rate therefore fell to 28.3% in
2013-14 from 30.4% in 2012-13, in nominal terms. An improvement in investment efficiency is critical to encourage
fresh investments and drive growth.
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Supply-side GDP growth (y-o-y %)
H1FY14 H2FY14 FY13 FY14
GDP at factor cost 4.9 4.6 4.5 4.7
Agriculture 4.5 4.9 1.4 4.7
Industry 1.1 -0.3 1.0 0.4
Mining & Quarrying -2.0 -0.8 -2.2 -1,4
Manufacturing 0.1 -1.5 1.1 -0.7
Electricity, gas and w ater supply 5.8 6.1 2.3 5.9
Construction 2.7 0.7 1.1 1.6
Services 6.8 6.8 7 6.8
Trade, hotels, transport & communication 2.6 3.4 5.1 3.0
Financing, insurance, real estate and business services 12.5 13.2 10.9 12.9
Community, social & personal services 6.8 4.4 5.3 5.6
Source: CSO
Demand-side GDP growth (y-o-y %)
H1FY14 H2FY14 FY13 FY14
GDP at market price 4.7 5.3 4.7 5
Private Consumption 4.2 5.4 5 4.8
Govt. Consumption 6.5 1.6 6.2 3.8
Fixed Investment 0.2 -0.4 0.8 -0.1
Change in Stocks 2.5 0.9 -9 1.6
Exports 6 10.9 5 8.4
Imports 1 -6 6.6 -2.5
Source: CSO
OutlookIn 2014-15, assuming normal monsoons, we expect GDP to rise by 6%. This will be led by higher industrial growth driven
by infrastructure projects, many of which were cleared last year. But if the monsoons fail - the Indian Meteorological
Department has assigned a 60% chance of the El Ninophenomenon occurring this year - GDP growth could be lower, at
5.2%.
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CAD falls in 2013-14; to widen in 2014-15India's current account deficit (CAD) narrowed sharply to $32.4 billion (1.7% of GDP) in 2013-14 from $87.8 billion (4.7%
of GDP) in 2012-13. The reduction in CAD was primarily due to contraction in merchandise imports and rise in services
exports. However, in 2014-15, CAD is expected to widen to 2.2% of GDP as restrictions on gold imports are lifted.
Lower CAD in 2013-14 due to sharp fall in imports
The reduction in CAD in 2013-14 was led by merchandise trade deficit falling sharply to $147.6 billion (7.5% of GDP)
from $195.7 billion (10.5% of GDP) in 2012-13, and a 12.4% growth in net services receipts.
While merchandise exports growth at 3.9% provided some support, the sharp narrowing of the merchandise trade deficitwas on account of a 7.2% decline in imports. Gold imports fell to $28.9 billion in 2013-14 from $53.8 billion in the
previous fiscal, and imports, excluding oil and gold, also declined by 4.3% year-on-year due to weak domestic demand.
Net services, however, was driven by a pick-up in IT/ITeS and financial services exports, which benefited from a strong
rupee depreciation during the year and recovery in the US and Eurozone economies.
CAD drops in 2013-14 as gold imports decline
-1.2
-1.0
-1.3
-2.3
-2.8-2.7
-4.2
-4.7
-1.7
0
10
20
30
40
50
60
-5.0
-4.5
-4.0
-3.5
-3.0
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14
Gold imports ($ bn) (RHS)
CAD % of GDP (LHS)
Source: Reserve Bank of India, CRISIL Research
Capital inflows sufficient to finance CAD
Capital inflows of $48.8 billion on the back of a surge in inflows under foreign currency non-resident (FCNR) deposits
were more than sufficient to finance the CAD in 2013-14, resulting in a $15.5 billion accretion to India's foreign exchange
reserves. Net capital inflows received a significant boost from FCNR deposits mobilised in the third quarter under the
swap scheme offered by the Reserve Bank of India (RBI). FCNR deposits more than doubled to $38.9 billion in 2013-14
from $14.8 billion in 2012-13.
Despite a sharp slowdown in growth in 2013-14, there was a marginal pick-up in longer-term and less volatile capital
flows such as net foreign direct investment (FDI) (to $21.6 billion from $19.8 billion) and external commercial borrowings
(to $10.7 billion from $8.6 billion). In contrast, short-term inflows such net foreign institutional investments (FIIs) and trade
credit plummeted. Net FII inflows fell to $5 billion (5-year low) in 2013-14 from $27.6 billion in 2012-13, and there were
BOP
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net outflows of $5 billion on trade credit and advances in 2013-14 as compared to net inflows of $21.7 billion in the
previous fiscal. The decline in trade credit was mainly due to lower inflows on account of a sharp decline in merchandise
imports in fiscal 2014.
At end-December 2013, India's external debt stood at $426 billion - 5.2% higher than its level of $404.9 billion at end-
March 2013. The rise was mainly due to an increase in long-term debt, driven by higher NRI (non-resident Indian)
deposits. The share of short-term external debt in total external debt fell to 21.8% in end-December 2013 from 23.9% at
end-March 2013 due to a decline in short-term trade credit and advances.
OutlookIn fiscal 2015, we now expect CAD to widen to $47 billion (2.2% of GDP) as restrictions on gold imports, imposed since
July 2013, are gradually withdrawn. The RBI has already begun to take steps in this direction by allowing large private
gold importers to resume importing gold and permitting nominated banks to give gold metal loans to jewellery
manufacturers. Imports of capital and consumption goods (non-oil, non-gold imports) are also expected to rise this year
as GDP growth picks up to 6.0%. Despite pressure from rising imports, the upside to CAD is likely to be capped due to
faster growth in exports, led by a west-led global recovery.
Financing CAD, however, may pose a challenge in 2014-15 as global liquidity declines with continued tapering of the US
Fed's bond purchase programme. There will also no longer be a cushion from FCNR deposits as was the case last year.
Under these circumstances, the government's ability to revive investor sentiment and lift growth will be key to attracting
portfolio and FDI flows.
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IIP remains negative, dips 0.5% in March
Industrial production numbers continued to disappoint, with output declining 0.5% in March and for the the fourth quarter
of 2013-14 (January-March 2014). Even if we were to assume that the construction sector grew at an average of 2.6%
(for the first 3 quarters), fourth-quarter GDP industry growth is barely 0.4%. This is less than the 1% industry growth
required in the fourth quarter of 2013-14 to achieve overall GDP growth of 4.9% in 2013-14 estimated by the government
and suggests a possible downward revision in GDP estimates unless agriculture and service sector output surprise on
the upside.
Sectoral growth (y-o-y,%)
Weight Mar-13 Mar-14 FY13 FY14
General 1,000.00 3.5 -0.5 1.1 -0.1
Mining 141.6 -2.1 -0.4 -2.3 -0.8
Manufacturing 755.3 4.3 -1.2 1.3 -0.8
Electricity 103.2 3.5 5.3 4.0 6.1
Basic 355.7 3.2 4.0 2.4 2.0
Capital 92.6 9.6 -12.5 -6.0 -3.7
Intermediates 265.1 2.1 0.6 1.6 3.0Consumer Goods 286.6 1.8 -0.9 2.4 -2.6
-Durables 53.7 -4.9 -11.8 2.0 -12.2
-Non durables 233 7.3 7.2 2.8 5.2
April - Mar
Use -based classification
Source: CSO
Manufacturing and mining output disappointed in 2013-14 though mining activity resumed lately in Karnataka and Goa.
Manufacturing output fell 0.8% in 2013-14 as it succumbed to weak private consumption, while mining output also
declined by 0.8%. The only driver of industrial production this year has been the surge in electricity output (by 6.1%)
where some improvement in coal supply and higher capacity additions benefited the sector.
Industrial Production
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Electricity production lifts IIP while others slow down
-12.0
-8.0
-4.0
0.0
4.0
8.0
12.0
Feb-13
Mar-13
Apr-13
M
ay-13
Jun-13
Jul-13
Aug-13
Sep-13
Oct-13
N
ov-13
D
ec-13
Jan-14
Feb-14
Mar-14
%yoy,3MMA
IIP Overall IIP Manufacturing Mining and Quarrying Electricity
Source: CSO, CRISIL Research
The manufacturing sector continued to shrink. Of the 22 industrial sub-sectors, 12 industries noted negative growth
during the month.
Laggards in the manufacturing sector (y-o-y, %)
Industries Weight Mar-13 Mar-14 FY13 FY14
Radio, TV and communication equipment & apparatus 9.9 -8.7 -33.1 5.6 -27.3
Off ice, accounting & computing machinery 3.1 -21.4 -26.1 -13.9 -15.8
Medical, precision & optical instruments, w atches and clocks 5.7 40.3 -21.5 -2.0 -5.0
Motor vehicles, trailers & semi-trailers 40.6 -2.9 -14.2 -5.3 -9.6
Fabricated metal products, except machinery & equipment 30.9 -10.4 -11.9 -4.7 -7.2
Furniture; manufacturing n.e.c. 30.0 -8.0 -10.2 -5.1 -13.8
Wood and products of w ood & cork except furniture; articles of
straw & plating materials10.5 -3.3 -8.3 -7.1 -2.1
Electrical machinery & apparatus n.e.c. 19.8 65.9 -6.5 0.6 14.3
Publishing, printing & reproduction of recorded media 10.8 -22.6 -4.0 -5.1 0.3
Tobacco products 15.7 32.9 -3.8 -0.4 1.6Paper and paper products 10.0 1.6 -3.4 0.5 0.0
Other non-metallic mineral products 43.1 3.6 -0.2 1.9 1.0
April - Mar
Source: CSO
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Performers in the manufacturing sector ( y-o-y,%)
Industries Weight Mar-13 Mar-14 FY13 FY14
Textiles 61.6 5.0 0.1 5.9 4.1
Machinery and equipment n.e.c. 37.6 -2.7 0.5 -4.7 -4.8
Luggage, handbags, saddlery, harness & footw ear; tanning
and dressing of leather products5.8 11.9 1.8 7.3 5.0
Coke, ref ined petroleum products & nuclear fuel 67.2 13.1 2.0 8.5 5.2
Chemicals and chemical products 100.6 2.6 2.4 3.8 8.9
Other transport equipment 18.3 -6.5 2.8 -0.1 5.6
Rubber and plastics products 20.3 -2.6 4.6 0.2 -2.3
Food products and beverages 72.8 -0.9 6.2 2.9 -1.3
Basic metals 113.4 2.6 9.2 1.9 0.3
Wearing apparel; dressing and dyeing of fur 27.8 160.7 26.0 10.4 22.6
April - Mar
Source: CSO
Sharp revisions in past estimates put core sector data reporting under question
Steel production too slightly rose in 2013-14. With all other core sectors seeing lower growth in outpoutand natural gas
production falling by nearly 12%, output of the eight core sector industries grew 2.6% compared to 5.3% in 2012-13.
However, the quality of data released for core sector production is increasingly being challenged owing to massive
correction in past data. March 2013 core sector data, for instance has been revised up to 7% from 3.2% reported earlier.
The index of core industries has a 38% weightage in the IIP, which directly enters into the quarterly and annual GDP
estimates. In India, final GDP numbers are based on data from the Annual Survey of Industries. As these figures are only
available with a time lag, advance and quick estimates for GDP are based on IIP data. In the past too, sharp revisions in
industrial output data have resulted in correction of GDP estimates.
India Inc less optimistic of a pick-up in Q12014-15...
In terms of use-based classification, consumption goods production fell in 2013-14 owing to a sharp decline in consumer
durables' output, given weak demand in a 'low income growth-high inflation' environment.
In 2013-14, sales of household appliances such as refrigerators, air-conditioners and washing machines barely grew by
3-4%, while in the automobile sector, cars and utility vehicle sales fell 6%. In the capital goods segment, production fell
for the third consecutive year in 2013-14 as the investment climate worsened further. As per the RBI's industrial outlook
survey in the fourth quarter of 2013-14, India Inc. appears less optimistic of a pick-up in the first quarter of 2014-15. The
overall optimism on production, order books and capacity utilisation was also less optimistic vis-a-vis the fourth quarter,
but the outlook on exports improved.
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Production of consumer and capital goods weighs on overall IIP
-12.0
-8.0
-4.0
0.0
4.0
8.0
F
eb-13
M
ar-13
Apr-13
M
ay-13
Jun-13
Jul-13
A
ug-13
S
ep-13
Oct-13
N
ov-13
D
ec-13
Jan-14
F
eb-14
M
ar-14
%yoy,3MMA
IIP Consumer goods Intermediary goods IIP Capital goods Basic goods
Source: CSO, CRISIL Research
...but expect consumption and export-oriented sectors to fare better
Nevertheless, some improvement in the investment climate is forthcoming due to the gradual release of stalled
infrastructure projects and a pick-up in mining output. Assuming a decisive political outcome in the general elections and
a normal monsoon, the industry could see some revival. The foremost risk to growth in 2014-15 is from a sub-normal
monsoon, which could impact farm incomes and demand, and have spill-over effects on industry via higher input costs.
CRISIL Research estimates consumption and export-oriented sectors to perform better in 2014-15, while infrastructure-
led sectors could also see some uptick. If a fractured political outcome is what we get, investment-linked sectors could
take the biggest hit, while a weak monsoon could mar prospects for consumption-driven sectors.
OutlookDomestic demand remains weak for now and a sluggish IIP growth in the fourth quarter suggests a possible downward
revision in the GDP estimate for 2013-14.
However in 2014-15, we expect industrial growth to look up - growth (as reflected in industry GDP, which includes
construction) is estimated to go up to 4% from 0.6% in 2013-14. However, this would still mean less than half the growth
of 8.5% witnessed between 2002-03 and 2011-12. A sustained and high growth in industrial production beyond fiscal
2015 will require policy focus on easing input constraints and significant improvement in the investment climate.
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Exports bounce back, imports decline in April
Merchandise trade deficit narrowed sharply to $10.1 billion in April 2014 from $17.7 billion a year ago, led by a modest
recovery in exports and a sharp decline in imports.
After declining for two consecutive months, exports bounced back in April, growing at 5.3% on a year-on-year (y-o-y)
basis. The recovery was driven by strong growth in engineering goods, readymade garments, marine products,
pharmaceuticals and leather exports.
Since November 2013, growth in exports has decelerated significantly due to slowing petroleum and gems and jewelleryexports, which together account for one-third of overall exports. In April too, petroleum exports grew by a mere 0.7% y-o-
y, while exports of gems and jewellery contracted by 8.1% y-o-y.
What pushed up growth in exports in April?
21.3
10.4
14.3
42.2
30.4
0.7
-8.1
22.3
4.9 5.2
1.5 1.8
20.1
12.8
EngineeringGoods
Drugs &Pharmaceuticals
Readymadegarrments
Marine Products Leather & leatherproducts
PetroleumProducts
Gems &Jewellery
Growth (%, y -o-y ) Share in ex port s (%)
Note: Figures are based on quick estimates released by the Ministry of Commerce and Industry in April
Source: Ministry of Commerce and Industry, CRISIL Research
In contrast, imports fell by 15% in April compared to a year ago. The decline in imports was broad-based driven by both,
lower gold and well as non-gold imports. Continued contraction in imports excluding gold indicates still slowing demand
for capital and consumption goods due to weak domestic demand. Falling oil imports also mirrored the underlying
weakness in domestic demand.
Gold imports fell to $1.76 billion in April from $6.8 billion a year ago due to restrictions on importing gold since July
2013.
Non-oil imports after excluding gold were 5.4% lower than a year ago, showing no signs of a recovery in domestic
demand.
Despite higher oil prices compared to a year ago - $108/barrel in April 2014 compared to $102/barrel in April 2013 -
oil imports fell by 0.6% y-o-y due to falling import volumes.
External Sector
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Exports rose and imports fell in April
-20
-15
-10
-5
0
5
10
15
20
Apr-13
May-13
Jun-13
Jul-13
Aug-13
Sep-13
Oct-13
Nov-13
Dec-13
Jan-14
Feb-14
Mar-14
Apr-14
y-o-y,%
Export growth Import growth
Source: Ministry of Commerce and Industry, CRISIL Research
Trade performance
Apr-13 Apr-14 2012-13 2013-14
Exports 24.4 25.6 300.4 312.4
Imports 42.0 35.7 490.7 450.9
Oil Imports 13.1 13.0 164.0 167.6Non-oil Imports 29.0 22.7 326.7 283.3
Trade deficit -17.7 -10.1 -190.3 -138.6
Exports 2.5 5.3 -1.9 4.0
Imports 11.2 -15.0 0.3 -8.1
Oil Imports -3.7 -0.6 5.9 2.2
Non-oil Imports 19.5 -21.5 -2.1 -13.3
Trade deficit 25.9 -42.9 4.0 -27.2
April-Mar
Merchandise Trade (US$ billion)
y-o-y %
Source: Ministry of Commerce and Industry, CRISIL Research
OutlookIn fiscal 2015, growth in exports is expected to gain momentum with global recovery. However, imports too will rise as
curbs on gold imports are withdrawn and imports of oil, consumption and investment goods pick up with recovery in GDP
growth. Overall, current account deficit is forecast to widen this year. However, the magnitude of slippage will depend on
the timing and extent to which existing restrictions on gold imports are relaxed and the pace of recovery in GDP growth.
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Diverging trends in CPI & WPI
Retail inflation jumped up to 8.6% in April from 8.3% in the previous month, as food inflation rose to 9.8%. While
vegetable and fruit prices contributed 50% to the rise in overall inflation, core inflation remained unchanged in April.
As growth improves this year, higher demand will keep core inflation firm. However, even if retail inflation hovers at 8.3-
8.8% in the coming months, the Reserve Bank of India (RBI) is likely to hold ground (keep rates unchanged) at its
monetary policy review in June 2014, until the underlying inflation momentum is evident.
CPI inflation - Headline and core (y-o-y %)
6
8
10
12
14
16
Apr-12
May-12
Jun-12
Jul-12
Aug-12
Sep-12
Oct-12
Nov-12
Dec-12
Jan-13
Feb-13
Mar-13
Apr-13
May-13
Jun-13
Jul-13
Aug-13
Sep-13
Oct-13
Nov-13
Dec-13
Jan-14
Feb-14
Mar-14
Apr-14
Core Inf lat ion (CPI -ex cluding food and fuel) Headline inf lat ion F ood inf lat ion
RBI target of 8%
Note: RBIs Target of 8% is till January 2015
Source: CSO, CRISIL Research
CPI Inflation edges up with rising food inflation
CPI inflation rose to 8.6% in April from 8.3% in the previous month, the highest in three months. This was driven by a rise
in food inflation to 9.8% y-o-y from 9.2% in the previous three months. Inflation in all food items rose (except egg, meat
and fish and non-alcoholic beverages). Fruits and vegetables contributed 28% to the spurt in food inflation.
CPI core inflation (excluding food and fuel & light) remained unchanged at 7.7% y-o-y in April for the third consecutive
month. The number has remained sticky, averaging 8% in 2013-14. Growth is expected to pick up this fiscal to 6%,
closing the gap with potential output. This implies that the output gap is likely to shrink this year and high demand is likely
to cap any considerable fall in core inflation. Inflation in clothing, bedding & footwear, medical care, education, recreation,
personal care and household requisites (60% weight in core) is also likely to remain sticky.
Inflation
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CPI components (y-o-y %)
CPI (%y-o-y)
Apr-13 De c-13 Jan-14 Fe b-14 Mar-14 Apr-14 FY13 FY14
Headline CPI 9.4 9.9 8.8 8.0 8.3 8.6 10.2 9.5
Food, Bev & Tobacco 10.7 12.0 9.9 8.6 9.2 9.8 11.8 11.1
Fuel & Light 8.1 7.0 6.5 6.1 6.3 6.0 8.6 7.4
Core CPI 8.1 7.9 8.0 7.7 7.7 7.7 8.6 8.0
Housing 10.6 7.0 6.5 6.1 6.3 6.0 11.3 10.4
Clothing, bedding & footw ear 10.3 9.2 9.1 9.1 9.0 8.8 10.9 9.3
Misc. 7.0 7.0 7.1 6.8 6.8 6.9 7.3 6.8
April-March
Source: CSO, CRISIL Research
WPI reverses trendWholesale price index (WPI) inflation fell to 5.2% from 5.7% in March. Overall inflation was driven down by lower food
& fuel inflation (within the WPI basket). In April, fuel inflation edged down by 9% y-o-y from 11.2% in the previous month.
Food inflation also moderated to 6.3% y-o-y from 7.1% in March. By contrast, the CRISIL's core inflation indicator edged
up to 3.6% from 3.4%.
WPI inflation (y-o-y %)
0
2
4
6
8
10
12
14
16
18
April-12
May-12
June-12
July-12
August-12
September-12
October-12
November-12
December-12
January-13
February-13
March-13
April-13
May-13
June-13
July-13
August-13
September-13
October-13
November-13
December-13
January-14
February-14
March-14
April-14
Overall WPI Primary Fuel, Power Manufacturing Source: Ministry of commerce and industry, CRISIL Research
OutlookThe enhanced possibility of an El Nino in 2014 could push up CPI inflation, as agriculture-related articles have 50%
weightage in the CPI. In such a case, high inflation in food articles such as vegetables, fruits, milk & milk products will
keep retail inflation firm. However, on the upside, inflation is likely to be capped as the lagged impact of previous rate
hikes seeps through and a strong base effect from last year lowers headline inflation.
Balancing these risks, we expect CPI headline inflation to hover at 8.3-8.8% in the coming months. With the RBI
recently reemphasising its intent to lower inflation to 8% by January 2015 and to 6% by January 2016, we expect it to
keep the repo rate to remain unchanged for now - standing in a wait and watch mode.
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CRISILEcoView
Policy rates held unchanged, SLR slashed
In its second bi-monthly monetary policy statement on June 3, the Reserve Bank of India (RBI) left the policy rates
unchanged. The statement hinted at a dovish stance of the RBI as compared to the previous statements. The RBI said
that if the economy stays on course, further policy tightening will not be warranted. Keeping the repo rate unchanged at
8%, the central bank brought down the statutory liquidity ratio (SLR) of scheduled commercial banks by 50 basis points
from 23.0% to 22.5% of their Net Demand and Time Liabilities (NDTL).
Policy rates
3.0
6.0
9.0
12.0
Jan-1
2
Mar-1
2
May-1
2
Jul-1
2
Sep-1
2
Nov-1
2
Jan-1
3
Mar-1
3
May-1
3
Jul-1
3
Sep-1
3
Nov-1
3
Jan-1
4
Mar-1
4
May-1
4
%
Repo Rate MSF Call Rate Term repo
Source: RBI
Policy rates remain firm on inflation risks
In its policy statement, the RBI reiterated its resolve to bring down and sustain CPI inflation below 8% by January 2015
and further to 6% by January 2016. Headline inflation increased to 8.6% in April after recording a decline in the first 2
months of the year. Core CPI inflation has edged down slightly, but remains high at around 8%. Recent upward
movement in headline inflation was due to higher vegetable and fruit prices on the back of weather-related disturbances
and may prove to be transitory. In the coming months, a strong base effect of high inflation during June-November 2013
could soften CPI inflation.
However, upside risks to inflation stemming from the enhanced possibility of the occurrence of the El Nino this year,
could lead to weaker-than-normal monsoon and push up food inflation. This will limit the room with the RBI to ease policy
rates. Policy action on the fiscal front too will be closely watched by the RBI. Swift action by the government to tame food
inflation and commitment to fiscal discipline in the forthcoming Union Budget will provide the RBI elbow room for a pro-
growth monetary stance. Controlling inflation is even more pertinent as the revival in growth can limit the moderation in
core inflation. The RBI maintains its baseline projection of GDP growth in FY15 at 5.5%. CRISIL Research, however,
expects growth to be higher this fiscal at 6% compared with 4.7% in FY14, led by the assumption of normal monsoon
and higher industrial growth driven by infrastructure projects, many of which were cleared last year.
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A liquidity push to the banking system
In an effort to provide more room to banks to finance higher credit demand as the economy recovers, the RBI, in its June
review, reduced the SLR for banks, by 50 bps to 22.5% of NDTL. The SLR cut, has the potential to free nearly Rs 400
billion in the banking system. Today, banks have limited room to lend given the rising NPAs, large portfolio of stressed
assets and low deposit growth.
However, the SLR cut is unlikely to have a direct impact on liquidity since banks usually hold government securities well
above this mandated ratio since these give reasonable risk-free returns of around 8.6% returns. As of mid-May 2014,
banks' investments under the SLR stand at 27.5%.
Along with the reduction in SLR, the central bank reduced the liquidity provided under the export credit refinance (ECR)
facility from 50% of eligible export credit outstanding to 32%. However, it introduced a special term repo facility of 0.25%
of NDTL to compensate fully for the reduction in access to liquidity under the ECR facility. In an effort to further develop
the term money market, the RBI announced to conduct a 4-day term reverse repo auction for an amount of Rs.
15,0 billion on June 2, 2014.
Liquidity eases in May
During the month of May, the RBI raised Rs. 750 billion via auction of government dated securities. In addition, the
central bank also raised Rs. 687 billion via T-bills. Liquidity conditions eased in May as the average borrowings of
scheduled commercial banks from the RBI under the repos, term repos and the MSF was Rs. 750 billion, down from
Rs. 821.81 billion in April. Weighted average short-term borrowing cost for banks in May (under repo rate, MSF rate and
term repos) reduced to 8.25% from 8.31% in the previous month. As liquidity eased in the banking system, call rates
averaged 7.8% in May, 20 bps less than that in the previous month. In its April 2014 monetary policy announcement, the
RBI had slashed the liquidity available under the overnight repos to 0.25% of NDTL from 0.5% earlier, leading to a sharp
fall in borrowings under the repo auctions.
In line with the fall in call rates, money market interest rates too softened in May, falling by 16 bps for the 6-month CD
and 1 bps for the CP of the same tenure.
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CRISILEcoView
Liquidity conditions ease in May (Rs. billion)
-500
0
500
1000
1500
2000
Feb-14
Mar-14
Apr-14
May-14
Net Repo borrowings Term Repos Marginal Standing Facility
Source: RBI
Money markets interest rates ease in May
% CP rates CD rates
May-13 8.5 8.1
Jun-13 8.6 8.2
Jul-13 9.8 9.0
Aug-13 12.0 10.8
Sep-13 10.9 10.3Oct-13 9.6 9.1
Nov-13 9.6 9.1
Dec-13 9.5 9.0
Jan-14 9.6 9.1
Feb-14 9.8 9.4
Mar-14 9.9 9.6
Apr-14 9.3 9.0
May-14 9.2 8.8
Note: Average interest rates across maturities
Source: CCIL, CRISIL Research
Bank credit growth remains muted
According to the latest data on sectoral credit offtake, credit to agriculture increased by 14.8% in April on a y-o-y basis.
Credit to industry increased by 12.3%, while that to the services sector increased by 17.1%. Barring industry, agriculture
and services sector saw acceleration in credit growth in April 2014, compared to April 2013.
Credit growth has remain at muted levels so far in the fiscal. For the fortnight ending May 16, bank credit grew by
13.4%, as compared to 14.7% during the same period last year. CRISIL Research expects credit growth in the banking
sector to improve to 16-18% in 2014-15, especially in the second half, given the decisive mandate in the elections. Bank
deposits are forecast to grow at around 15-16% in 2014-15, a tad higher than that in 2013-14. With expected moderation
in CPI inflation, real returns on deposits will turn positive.
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Scheduled commercial bank indicators (y-o-y %)
2013 2014 2013-14 2014-15
Aggregate deposits 13.5 14.3 4.8 1.5
Investments 12.2 12.4 4.3 3.6
Non-food credit 14.7 13.8 3.8 0.2
Bank credit 14.7 13.4 4.0 0.5
M3 12.6 13.5 1.9 2.1
Credit-Deposit Ratio* 77.5 76.9 65.2 25.9
Outstanding as on
16th May
Financial year so far
Source: RBI
OutlookIn the coming months, a strong base effect of high inflation during June-November 2013 could soften CPI inflation. The
big worry is the enhanced possibility of the occurrence of the El Nino this year, which could lead to a weaker-than-normal
monsoon, cranking up food inflation. Given the uncertainties, the RBI's decision to hold interest rates steady is
appropriate. We expect the central bank to hold rates unless inflation comes down sharply.
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CRISILEcoView
Positive election outcome strengthens rupee
The rupee appreciated in May, ending the month at Rs.59.0/$, as compared to Rs.60.3/$ as of April-end. On a monthly
average basis, the rupee appreciated by 1.7% to Rs.59.3/$ in May.
A landslide victory by the National Democratic Alliance (NDA) during the month - winning 336 out of 543 seats - in the
general elections bode well for the currency markets. The decisive mandate is expected to speed up resolution of policy
bottlenecks, and quicken pending reforms and project implementation, boost private sector and foreign investor
sentiments via the signaling channel. Consequently, the rupee, which averaged Rs.60/$ in the first half of the month,
appreciated to Rs.58.8/$ in the second half. Also data released on current account deficit (CAD) for the year providedpositive cues. CAD fell to 1.7% of GDP in 2013-14 from 4.7% in 2012-13. In absolute terms, CAD was $55.4 billion lower
than in 2012-13.
The appreciation in the rupee was also supported by a surge in foreign institutional investments. Net foreign institutional
investments (FIIs) stood at $5.7 billion in May compared to $0.1 billion in April. While equity flows were higher during the
month, higher debt inflows at $3.3 billion compared to net outflows of $1.5 billion lifted the rupee. In addition, a decline in
the trade deficit continued to ease the pressure on dollar demand.
Rupee appreciates in May as FIIs pour in funds
-2
-1
0
1
May-13
Jun-13
Jul-13
Aug-13
Sep-13
Oct-13
Nov-13
Dec-13
Jan-14
Feb-14
Mar-14
Apr-14
May-14
52.0
54.0
56.0
58.0
60.0
62.0
64.0
66.0
68.0
70.0Net FI I inflow US$ billion (LHS) Rs per USD
Source: Securities and Exchange Board of India, Reserve Bank of India (RBI)
The rupee was slightly more volatile in May, trading in a range of 58.4-60.2/$. In the forward market, the one-month
premia fell by about 65 basis points (bps) while the 6-month premia fell 330 bps as compared to April, reflecting
expectations of some appreciation in the currency.
Currency
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Currency movement (monthly averages)
USD GBP Euro Yen
FY 13 54.4 86.0 70.1 65.9
FY 14 60.5 96.0 81.0 60.4
H1FY14 59.1 90.8 77.8 59.8
H2FY14 62.0 100.5 84.0 61.8
Q4FY14 61.8 102.2 84.6 60.1
April-14 60.4 101.1 83.3 58.9
May-14 59.3 99.9 81.5 58.3
1-month 8.6
6-months 8.4
Indian Rupee vis--vis
Forward premia*
* As of May 23, 2014; # Monthly average
Source: RBI
OutlookCRISIL Research expects the rupee to settle at 60 per US dollar by March-end 2015, due to a slight widening of CAD.
However monetary easing in the Eurozone, improved domestic growth prospects and potential opening up of FDI across
sectors will attract higher capital inflows and will cap the fall in the rupee.
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CRISILEcoView
Stable election result drives yields lower
Month-end yields on the benchmark 10-year government bond (8.83%, 2023) declined to 8.64% in May from 8.83% in
April. This was on account of a decisive election result and hopes that the new government would enforce fiscal
discipline, among other things. This also boosted foreign investment inflows into the debt market. Further, lower liquidity
requirements helped ease yields. However, higher consumer price index (CPI) inflation and caution ahead of the
monetary policy meeting in June limited a further fall in the yields.
Election result, FII inflows lowered yields...
During the month, net foreign institutional investor (FII) inflows into Indian debt surged. FIIs turned net buyers in the debtmarket in May after retreating from the debt markets in the previous month - net FII inflows into the debt markets stood at
$3.3 billion as compared to an outflow of $1.5 billion in the previous month. A clear majority in the general election and a
favourable election result helped boost market sentiment in May. Comments by the new finance minister, Arun Jaitley, to
bring down inflation and fiscal deficit were encouraging for investors. These factors led to lowering of yields during the
month. However, the fall in yields was limited ahead of the release of the fiscal deficit data.
CPI inflation rose to 8.6% in April from 8.3% in March as food inflation soared. The increasing likelihood of lower rainfall
and occurrence of an El Nino by the Indian Meteorological Department raised fears of higher inflation. Also, the
impending Union Budget casts a shadow of uncertainty over fiscal discipline and its impact on inflation in this fiscal.
However, due to the high base effect from last year (July-November 2013), inflation pressures could ease in the coming
months.
Balancing these risks, the Reserve Bank of India (RBI) kept rates on hold in its monetary policy meeting on June 3, 2014
till these temporary shocks wore off. It said that if the economy continues on the current course, future rate hikes might
be unwarranted. Also, higher-than-expected dis-inflationary pressures apart from the base effect might result in an
easing monetary stance.
...supported by lower liquidity conditions
Liquidity conditions eased during the month, lowering yields. This was reflected in the trend seen in the call money rateand the borrowings under liquidity adjustment facility (LAF). The interbank call money rate moved in a wide range of
7.00-9.15% in May, ending the month at 7.3%. Comfortable liquidity conditions for banks to cover reserve requirements
and low short-term demand for liquidity lowered call rates. Also, the government's oil subsidy payments to oil marketing
companies led to further easing of liquidity conditions.
Lower demand for funds was reflected in short-term borrowings as well. Average outstanding borrowings under the LAF -
repo and term repos - fell to Rs. 727 billion in May from Rs. 795 billion in April. Average outstanding borrowings at the
marginal standing facility (MSF) rate fell to Rs. 25.1 billion from Rs. 31.7 billion over the same period.
However, a fall in yields was capped following the government's weekly gilt auction, which included a new 14-year bond.
Debt
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Huge government borrowings likely to keep pressure on yields
The RBI, on behalf of the government, raised Rs. 750 billion via dated securities. The central bank set lower-than-
expected yields for the Rs. 160 billion bond auction on May 23, supporting overall bond prices during the month. The
central bank also raised Rs. 687 billion via treasury bills in May as compared to Rs. 993.9 billion raised in April. Higher
government borrowings scheduled in the coming months are expected to keep the pressure on yields. The government
proposes to borrow Rs. 3.7 trillion in the first half of 2014-15 - higher than borrowings of Rs. 3.3 trillion in the
corresponding period of the previous year.
The average yield on the 1-year G-sec bond edged down to 8.4% in May from 8.6% in the previous month. On a month-
end basis 1-year G-sec yields fell to 8.3% in May from 8.6% in April.
10-year G-sec yields (month-end, %)
8.6
8.0
8.8
8.64
5.0
7.0
9.0
FY12 FY13 FY14 May Jun* Jul* Aug* Sep* Oct* Nov* Dec** Jan** Feb** Mar** Apr May
FY14 FY15
Note: Month* corresponds to the 7.16%, 2023 benchmark 10-year government bond. Month** corresponds to the new
(8.83%, 2023) benchmark 10-year government bond.
Source: CCIL, CRISIL Research
Yield on the 10-year 'AAA' corporate bond fell by 50 basis points (bps) on a month-end basis to 8.64% by May-end. As
corporate bond yields fell moderately while government bond yields edged up only slightly, the month-end spread
between the two narrowed to 0.43 bps in May from 0.46 bps in April.
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CRISILEcoView
Spread between AAA corporate and 10-year G-sec (month-end)
0.7 0.7
0.6
0.0
1.0
2.0
FY12 FY13 FY14 May June* Jul* Aug* Sep* Oct* Nov* Dec** Jan** Feb** Mar** Apr MayFY14 FY15
Spread between AAA corporate & 10-year G-sec
Note: Month*: The spread between the 10-year corporate bond and the 10-year government bond (7.16%, 2023).
Month**: The spread between the 10-year corporate bond and the new 10-year government bond (8.83%, 2023).
Source: Fixed Income Money Market And Derivatives Association of India, CRISIL Research
OutlookBy March 2015, we expect 10-year G-sec yields to settle at 8.6%. Lower inflation in 2014-15 as compared to the last few
years, better liquidity conditions and liquidity management through term repos will also help ease the pressure on yields.
However, the fall in yields may be limited due to higher borrowing by the government this year. The fiscal deficit is
forecast to be at 4.3% of GDP as against the budgeted target of 4.1% of GDP. This means that net government
borrowings are likely to exceed budgeted targets and end up being higher than 2013-14 levels. A significant portion of
short-term debt issued during the crisis years (2008-09 and 2009-10) is due for redemption in the next fiscal. Some of
this outstanding debt has already been refinanced into longer tenure securities, while the remaining will be switched in
2014-15. This will create some interim upward pressure on 10-year G-sec yields.
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Sensex crosses 25,000-mark in May
The Indian equity markets were euphoric in May following the Lok Sabha elections. The S&P BSE Sensex, which started
the month at 22,403.89 points, ended at 24,217.34 points, gaining 1,813.45 points. The Sensex, as well as the Nifty,
yielded double-digit returns on a yearly basis.
healthy external trade data and a stable rupee lifted investor sentiments. In addition, merchandise trade deficit narrowed
sharply to $10.1 billion in April 2014 from $17.7 billion in the corresponding month of last year, driven by a modest
recovery in exports and a sharp decline in non-oil imports.
However, weak data on the Purchasing Managers Index (PMI) dampened investor sentiments. Manufacturing PMI for
India stood at 51.3 in April, same as in March. Inflation and index of industrial production (IIP) numbers too disappointed;
CPI inflation rose to 8.6% in April from 8.3% in the previous month, the highest in three months, while IIP fell by 0.5% in
March.
Indian markets rally in May on elections
8.9
6.0
5.2
4.8
20.1
18.2
18.9
16.8
CNX Midcap
CNX 500
S&P BSE Sensex
CNX Nifty
Yearly returns Monthly returns
(per cent)
Source: BSE, NSE
Key benchmark indices rallied in the week ending May 16, 2014. The S&P BSE Sensex settled at a record high after
crossing the 25,000-mark in intraday trade on Friday, May 16, 2014. Prior to