Inflation Figures

Morgan Stanley-India Research
Risk of Growth Dipping Below Potential Trend (2H08 - ??)
-GOI finances in total disarray.
-BOP in a mess.
-Fiscal Deficit closer to 10 per cent.
-Current Account Deficit closer to 3.5 per cent.
-RBI should stop messing around with CRR and raise interest rates.
-First time in 4 years, Real Interest Rates on Bank Deposits are negative,
that is interest paid is lower than annual inflation rate.

-Falling Rupee and lack of infrastructure imply growth at 9 per cent is simply
unsustainable.
-Millions of unemployed are a problem, rather than a demographic positive.
-Inflation to reduce and curtail spending power of the low and middle income
groups.

While growth has already reverted to more sustainable levels, the global
macroenvironment could force a further slowdown. Just as during the years
2005-07, strong positive global factors supported India's growth above its
then-sustainable growth trend, negative global factors are now threatening to
pull its growth below the potential.

The most important adverse factor is the global commodity price trend. While
India is self-sufficient in steel and aluminium, it is heavily dependent on
imported copper (concentrate), coking coal, edible oils, and, most important,
crude oil.

Even for commodities where the country is self-sufficient, market-oriented
pricing means some indirect pressure on domestic pricing of global commodity
products is inevitable. This is evident in the recent spike in prices for
domestic steel, iron ore, and certain food products.

Rising oil prices continue to be a big challenge for the country. India
imports about 70% of its crude oil and refined products requirements. A roughly
US$10/bbl increase in crude oil prices results in higher imports, trade deficit,
and current account deficit of US$7 billion (0.6% of GDP).

With the government having increased domestic fuel prices by only 26% for
petrol and 34% for diesel (average for the country) over the last four years
during the period in which international crude oil prices have shot up about
225% to US$129/bbl currently, the subsidy burden continues to spike.

In F2009 (12 months ending March 2009), if crude oil prices average
US$120/bbl, we believe the oil subsidy (including the burden on oil companies)
will increase to US$40 billion (3.3% of GDP).

As per our Oil and Gas analyst Vinay Jaising, domestic oil products are marked
to an implied average of US$65/bbl. If the government were to hike domestic
product prices to market, inflation would rise by about 6.9% points.

Even without the increase in domestic oil prices, the rise in other commodity
prices has already pushed inflation to close to a three and one-half-year high
of 7.8% during the week ended May 3, 2008 and the fiscal deficit (including
off-budget expenditures) to a five-year high.

The depreciation of the rupee will only add to the inflation pressures. The
inflation challenge is holding the Central Bank back from initiating much-needed
policy rate cuts. Higher inflation will slow spending by low- and middle-income
groups.

The increased global risk aversion and shrinking leverage of the financial
institutions will also affect the international funding plans of Indian
companies. Capital inflows into EMs and therefore into India could also slow.

Rohit