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Taking stock of the India story...

Mar 21, 2007

India's growth acceleration story over the past three years has been incredible. GDP grew by 9.2% YoY in FY07, the fastest pace in 18 years. Improving macro economic factors, strong demographic profile and better corporate performance have led to the strong economic growth. In this article we evaluate some of the key drivers and dampeners to the India growth story.India's GDP growth momentum is expected to continue in 2007 with the CSO's advance estimates projecting the real GDP growth at 9.2% in this calendar year against with world economy's expected growth rate of 4.9% YoY (as per World Economic Outlook). We, however, have a conservative estimation of the GDP growth number due to the following downsides.

Internal debt:Internal debt comprises loans raised in the open market, special securities issued to Reserve Bank, borrowings through treasury bills, commercial banks and non-interest bearing rupee securities issued to international financial institutions. Though the ratio of the internal debt to the GDP for FY07BE at 79% is lower than 81% in 2003 it has grown by a steep 26.7% YoY in this fiscal.

Fiscal deficit:The central expenditures have overshot the budget by about 3%. The total expenses increased by 15.4% YoY for the 9mFY07 period. However, due to a 37.6% YoY increase in the tax revenues, fiscal deficit witnessed a marginal improvement from the budgeted estimates of 3.8% of GDP. The government is expecting the fiscal deficit for FY08 to be around 3.3% of the GDP, it seems less likely as no major progress on expenditure reforms has been made. Also the revenue collections are likely to be less buoyant than the last year. The sticky fiscal deficit problem is yet likely to continue going forward.

Low agricultural growth: With 60% of the population dependent on the farm sector, low agriculture output has cast a shadow over the India growth story. Low and volatile growth in Indian agriculture and allied sectors was reflected in the advance estimates of National Income for FY07 released by the which has estimated a growth rate of barely 2.3% YoY for this sector.

Inflation:After three years of near double-digit growth, India's economy is showing signs of setting off an inflationary spiral. The rising food prices are impacting the non-urban residents more than their urban counterparts. Though inflation in India remains much lower than in many other developing countries, prices are rising more than twice as fast as in China. Wholesale price inflation has accelerated to 6% in March 2007 from 4% last year. In January 2007, food prices were 10% higher than what they were a year ago. Though the government has issued this as a 'key short-term priority' and taken steps to reduce liquidity, inflation a major cause of worry.

External debt:India's external debt touched US$ 136.5 bn at the end of September 2006. The rise in external debt outstanding at end-September 2006 was essentially brought about by a rise in external commercial borrowings, NRI deposits and short-term debt. Debt servicing as a proportion of gross external current receipts rose from 6.1% in FY05 to 10.2 % in FY06, mainly due to redemption payments of India Millennium Deposits. This is expected to remain flat going forward. If Indian corporates plan out more acquisitions across the globe, the figure of external debt could increase.

Passive reforms:Democracy and democratic values are relatively well-entrenched and the political system is largely stable. However, the existence of Coalition government in India may constrain the ability to implement economic reforms at a faster pace but will not stall any economic reforms. Also various social issues like education, healthcare, rural development and poverty have to be addressed to sustain growth. Though the government in the budget has planned on this front the problem of implementation needs to be solved.

Some of the key factors that can improvise our GDP estimations are:

Higher savings and investments:Saving rate of 32.4% will continue for the coming year. The rate has gone up by 3.3% as compared to 29.1 % in FY05. Overall, the rise in the savings rate has coincided with an increase in the rate of growth of GDP over the last three years, suggesting that the economy is in the mode of sustainable, higher growth trajectory. Also a massive increase in the inflow of portfolio FII investment in India's stock and debt markets has led to a surge in current savings. The strong GDP growth was also supported by a significant improvement in investments. Strong profits reported by the corporate sector, which accounts for 40% of the total capital formation, helped a 33.8% rate of capital formation.

Sustenance of FDI inflows:Inflows of foreign direct investment (FDI) into India have increased significantly during the last two years. FDI equity inflows during April 2006 to October 2006 were US$ 6.1 bn. This registers a massive increase of 134% YoY over the corresponding period last year. In the A T Kearney's FDI confidence index India's rank as a FDI investment destination has improved from number 15 in 2003 to number 2 in 2006. Also the FDI inflows for the first time were more than the FII inflow of US$ 1.6 bn. According to the government, the inflows in 2007 are likely to be more than double the amount recorded in 2006, which slows the rising investment confidence in India.

Higher industrial and services sector growth: Indian industrial output rose 11% YoY in the April to January period. Buoyant domestic demand and strong export growth propelled the steep rise. Manufacturing, which accounts for almost 15% of India's GDP also witnessed robust growth. A spurt in investment activity in construction and real estate led to a strong demand for capital goods.

The services sector accounts for a robust 63% of the economic output. This sector has been experiencing a high growth rate from past two years and its strong growth of 10% in FY06 was instrumental in propelling the overall GDP growth to a robust 8.4%

Accumulation of forex reserves:India had less than US$ 1 bn of foreign exchange (forex) reserves in 1991 and at that time the country had to pledge its gold to meet its import obligations. Subsequently, due to the liberalization of economic policies, there was a gradual increase in the reserves. It crossed US$ 50 bn in February 2002 and in December 2003 the country's forex reserves crossed the US$ 100 bn milestone. As of March 2007, the figure stood at US$ 180 bn. However, this figure is way below China's US$ 1,000 bn. While accumulation of forex reserves is a necessity, the country's flagging infrastructure base also calls for prudent utilisation of the reserves.

To conclude...

India's economic prospects remain strong. Higher consumption and investments, favourable demographics, proactive reforms and consistent fiscal policy have the steam to withhold the macro economic stability. India has emerged as a force to reckon with in the past decade. Having said that, investors must not turn a blind eye to the possible risks and continuously evaluate the performance of their investments and the broader economy.

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