Economic growth may moderate to 6.8-7% in FY12: ICRA

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ICRA has come out with its report on financial markets & banking update. According to the research firm Economic growth is expected to moderate in the second half of the current fiscal from the 7.3% growth recorded in H1FY12.

Highlights during quarter ended December 2011

• Sharp rise in Foreign Institutional Investors (FIIs) inflows backed by FII debt investments; FII equity flows remain marginally negative.

• Inflows from Foreign Direct Investment (FDI) moderate in Q2FY12 and Oct-Nov 2011 after a spike in Q1FY12; however, FDI inflows in April-Nov FY12 exceed inflows for the previous financial year.

• Inflows from External Commercial Borrowings (ECBs) remain strong. Flows may moderate going forward on account of increasing risk aversion. Volume of inflows from Foreign Currency Convertible Bonds (FCCBs) remains insignificant.

• Repo rate increase of 25 basis points (bps) instituted by the Reserve Bank of India (RBI) in October 2011, followed by a pause in monetary tightening in December 2011.

• Headline inflation eases in December 2011 led by a favourable base effect. Although inflation related to non-food manufactured products eases in December 2011, a sequential rise of 0.5% in the index level indicates inflationary pressures persist.

• Consumption and investment growth decline in Q2FY12; economic growth expected to moderate to 6.8-7.0% in FY12 from 8.5% in FY11.

• Credit growth slows to 16% in December 2011, lower than RBI's projected levels of 18%.

• Systemic liquidity tightens despite a moderation in year-on-year (y-o-y) credit growth, strong deposit growth and open market purchases of bonds carried out by the Central Bank ; substantial planned Government borrowings may keep liquidity tight in Q4FY12.

• Corporate bond issuance remains steady boosted by Non-Bank Finance Companies (NBFCs).

• Short term Corporate bond spreads widen whilst remaining volatile; yields on longer maturities soften.

Expectations
The persistence of inflationary pressures highlighted by the elevated inflation related to non-food manufactured products (7.7% in December 2011) is likely to prompt the RBI to leave the Repo rate unchanged in the upcoming policy review, despite the marginal 1% growth of the Index of Industrial Production (IIP) in the three months ending-November 2011. ICRA expects the RBI to announce further open market purchases of around Rs. 40,000-50,000 crore of bonds in the balance portion of Q4FY121 to bring LAF utilisation within the stated comfort zone and ensure availability of funds for economic growth. Moreover, a CRR cut in the near term is not anticipated, as it would weaken the Central Bank's focus on inflation management and may hamper the credibility of its communications strategy.

Economic growth is expected to moderate in the second half of the current fiscal from the 7.3% growth recorded in H1FY12, given the unfavourable trends regarding manufacturing and mining growth; lower area sown in FY12 so far under various rabi crops; and poor precipitation over substantial parts of southern India. Overall, ICRA expects growth to moderate to 6.8-7.0% in FY12 from 8.5% in FY11.

The deepening sovereign debt crisis in Europe and the likely fiscal tightening by various Advanced Economies going forward, would limit the demand for Indian exports. ICRA expects merchandise exports to rise to around US$ 285 billion in 2011-12, falling short of the target of US$300 billion set by the Government of India.

Given the slowdown in concrete announcements of fresh projects and capacity enhancement in the recent months and the likely delay in commissioning of certain projects, particularly in the power sector, investment growth is expected to remain sluggish in FY13. Economic growth may ease further in the coming fiscal, even if the monsoon conditions are favourable.

ICRA continues to expect headline inflation to ease to around 7% by March 2012, following an anticipated moderation in demand-side pressures in line with the slowing economic growth. However, a reversal in the recent appreciation of the rupee may exacerbate prices of imported commodities and inputs, fuelling inflationary pressures. Food inflation is expected to remain below 1% in January 2012, given the base effect, before rising to around 6-6.5% in March 2012.

Given that other asset classes are likely to generate moderate returns, ICRA expects the overall deposits growth to remain strong at 17-18% in FY12, stimulated by term deposits. With the Central Bank unlikely to cut rates in the current fiscal, credit growth in FY12 is expected to be in the range of 16-17%. Additionally, Corporate bond spreads (at the shorter end) are expected to remain volatile for some more time before stabilising. The remaining planned Government borrowing programme for Q4FY12 may lead to crowding out in the bond market, and long term bond issuance are expected to remain muted till there are some signs of easing of interest rates.

In the absence of a credible and lasting solution to the sovereign debt crisis in Europe, risk aversion is likely to remain high. Although the Indian economy is expected to expand at a slower pace in FY12 and FY13 relative to the 8.5% recorded in FY11, the pace of growth is likely to sharply exceed growth in the Advanced Economies, particularly as several of the latter may attempt greater fiscal tightening prompted by the recent downgrades of sovereign debt. The attractive returns, at least in the debt market in the near term, could ensure that FII debt flows are strong in the next 1-2 quarters.

With domestic interest rates expected to remain high in relation to Advanced Economies, which are persisting with easy monetary policies, Indian Corporates are likely to continue to tap the ECB route in the near term to take advantage of the interest rate differential. However, premiums for currency forward contracts have increased significantly owing to the recent volatility in the exchange rate of the rupee relative to various currencies, which could increase the all-in-cost of ECBs on a fully hedged basis. Moreover, the availability of funds from European lenders, as well as their risk appetite, is expected to diminish in the wake of the ongoing uncertainties in the Euro area.

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