Foreign Direct Investment (FDI) inflows year-to-date (YTD) up to November 2013 register a fall of ~7% over corresponding period of the previous fiscal. Notwithstanding deals announced in sectors like aviation, pharmaceuticals, retail, etc., policy uncertainty is likely to persist until the upcoming Parliamentary elections in Q1FY15, constraining a broad-based improvement in FDI flows.
Gross External Commercial Borrowings (ECBs) inflows in YTD November 2013 decline by 4.7% relative to the corresponding period of the previous fiscal, as hedging cost remained high on account of volatility in currency markets. In the near term, ECBs may remain unattractive to domestic firms without a natural currency hedge.
GDP growth improved to 4.8% in Q2FY14 from 4.4% in Q1FY14. However, despite a favourable monsoon, the pickup in domestic demand following the kharif harvest is weaker-than-anticipated. A meaningful revival in investment sentiment is likely to take place only after Parliamentary elections. Moreover, capacity constraints in some sectors and an adverse base effect may curtail the pace of growth of merchandise exports. Factoring in a pickup in agricultural growth to ~5.0% in the latter half of this fiscal, we expect Indian GDP growth to average around 4.8% in H2FY14. This suggests that growth would come in towards the lower end of our forecast band of 4.7-4.9%.
Wholesale and consumer inflation eased in December 2013 following a correction in vegetable prices. Although the brisk sowing of rabi crops suggest that food inflation would moderate further, double-digit inflation related to non-vegetarian protein items would impart some stickiness to food inflation. The persisting large under-recovery related to the retail price of diesel poses concerns for the inflation trajectory. Moreover, core inflation remains sticky both in terms of the wholesale and retail baskets.
The report of the Expert Committee to Revise and Strengthen the Monetary Policy Framework released in January 2014 recommended that CPI (combined) should be the new inflation anchor. This should be brought down to 8% in 12 months and 6% in 24 months, after which the recommended target of 4% +/-2% should be formally adopted. In ICRA's view, achieving the targeted moderation in CPI to 8% over the next 12 months may be feasible, if the monsoon in 2014 is favourable and there are no supply shocks for food items or other commodities. Given the weakness in consumer demand and contraction in industrial production in October-November 2013, we expect the RBI to retain the Repo rate in the Third Quarter Review of Monetary Policy. However, the commencement of a rate easing cycle appears to be distant.
Deposit growth improved to 15.8% as on December 27, 2013, overtaking credit growth for the first time this fiscal in December 2013, boosted by the USD 19 billion mobilised through FCNR(B) deposits from NRI depositors during October-November 2013 under the swap facility offered by the Reserve Bank of India (RBI) to boost forex inflows. Credit growth moderated to 14.7% as on December 27, 2013, as commercial paper (CP) issuances normalised post moderation in short term rates. On an aggregate basis, growth of Bank credit and CP outstanding on a year-on-year (y-o-y) basis eased to 14.3% at end-December 2013 from 14.6% at end-March 2013.
Systemic liquidity eased during Q3FY14, benefiting from the unsterilized inflows of USD 34 billion (since September 2013) through the swap windows for FCNR(B) deposits and Banks' overseas borrowings; measures such as the refinance facility for SIDBI; term repos of varying durations; and open market operations (OMOs). The RBI continued to unwind the exceptional liquidity measures that had been introduced in July-August 2013 and brought the Repo-MSF corridor back to the normal 100 bps. Although call rates moderated at the end of December 2013 as compared to September 2013, volatility remained high during Q3FY14. Liquidity is expected to be tight as generally seen in the fourth quarter, particularly given that Central Government spending is likely to be cautious in Q4FY14 in order to restrict the fiscal deficit to the target of 4.8% of GDP for FY14. ICRA expects the RBI to continue to address frictional liquidity concerns through a combination of term repos and OMOs.
Corporate bond issuances remain low as benchmark interest rates were steady during the quarter. The 10-year benchmark G-Sec yield rose from 8.50% at the end of last quarter to 8.77% at the end of Q3FY14, witnessing a high of 9.24% and low of 8.19% during the quarter, with the yield curve mostly remaining flat.
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