Risk of a slower GDP growth with little control on fiscal deficit, says Morgan Stanley
Government inaction could entail further deceleration in GDP growth to 4.3% in FY13, sharper depreciation of the exchange rate and a shock to the banking system by March 2014, says Morgan Stanley
Morgan Stanley Research has painted a weak picture of the Indian economy, with slower GDP (gross domestic product) growth and has advised caution on the part of the government in both monetary and fiscal policy. The report in its base case scenario (50% probability) says, “We are cutting our 2012 GDP growth estimates further to 5% from 5.7%. On a fiscal year basis, we have cut the FY13 GDP growth from 5.8% to 5.1% (a 10-year low). We believe that GDP growth for the next two quarters will be sub-5% as weak monsoons and the slowdown in external demand hamper growth.”
While in the base case scenario the advice to the government is on caution, there is a clear warning in the bear case scenario (35% probability). The report says that there is a risk of an even deeper growth shock. The report continues, “In the event of continued inaction from the government, we see very high risk of a potential “deeper macro stress” scenario. That could entail further significant deceleration in GDP growth to 4.3% in FY13, sharper depreciation of the exchange rate and a shock to the banking system by March 2014.”
The Morgan Stanley report adds that there is an urgent need for policy action from the government to address the deterioration in the fiscal deficit and persistent pullback in private investment.
The report justifies the lower growth forecast by saying that part of the cut in its FY13 estimate reflects the adverse impact of poor weather (lower-than-normal rainfall) on summer crop output, which typically accounts for about 7.5% of GDP. The other factors driving the reduction in the forecasts are:
(a) persistent bad growth mix (high fiscal deficit plus strong rural wage growth and simultaneous decline in private investment). This has brought a stagflation-type environment.
b) Renewed weakness in the external environment, as reflected in sharp deceleration in export growth.
From the government’s side, the report says that the most important action required is that the fiscal deficit needs to be contained. The report says, “We expect the national fiscal deficit to remain elevated at 8.9% of GDP in FY13. The high fiscal deficit has been a key factor behind high inflation and cost of capital. It has led to a multi-fold increase in government borrowing since the credit crisis. But for the RBI’s (Reserve Bank of India) aggressive open market operations, 10-year government bond yields would have been much higher than the current 8.23%.”
Finally, the Morgan Stanley report warns that private investment is maintaining a downward trend even if you are an optimist on GDP growth. The analysts believe that a decline in investment to GDP has been the main reason for taking the potential growth trend growth lower for India. Private investment, the most productive component of total investment, has fallen sharply as a portion of GDP from its peak in FY08 to FY12. Moreover, the current macro environment is very discouraging for entrepreneurs.
While FIIs (foreign institutional investors) are exercising caution on emerging markets like India, the report warns that from the domestic entrepreneurs’ perspective, several factors are affecting corporate confidence such as:
(a) The slowdown in domestic demand growth;
(b) The weak global economy and slowing export growth;
(c ) Weak global capital markets;
(d) Relatively high energy prices, inflation and cost of capital;
(e) Corruption-related investigations and slowdown in execution of the government’s administrative machinery.
The report expects the capex cycle to remain weaker for a longer period.