>COMING SEPTEMBER: HIKING GDP/BOP FORECASTS (MERRILL LYNCH)

■ Bottom line: India bottoming out to ~7% growth end-09…
We grow more and more comfortable with our January call of India bottoming out end-09 to ~7% growth. This leads us to hike our growth forecast to 6.3% in FY10 (from 5.3%) and 7.3% in FY11 (from 7.1%), assuming the 2H09 G-3 bottom out our global economics team expects. We have also grown more confident of our long-held twin view of BoP risks overdone/ medium-term constructive INR outlook: read Christy and me here. This, in turn, has led us to push our FY10 BoP
outlook up by US$14bn. Risks: monsoon, US$100+/bbl oil.

■ …although 4QFY09 ‘upside’ bit of statistical ‘construct’
We do not set much store by the fact that India’s 5.8% 4QFY09 GDP growth beat our (/consensus) 5% expectation. 40bp of the ‘upside’, after all, emanated from a concentrated higher-than-expected growth in construction (7% of GDP), due to an ever so convenient downward revision in its 4QFY08 growth to 6.9% from 12.6%.

■ Political stability allows pump priming by PSU divestment…
At the heart of our upgrade is a likely fiscal stimulus of 0.5-1% of GDP in the July budget. The convincing re-election of the Congress-led UPA, after all, has opened the door for ~0.5% of GDP of PSU divestment. Our estimates also suggest that the government can borrow an additional Rs500bn/US$10bn, in case the RBI steps in with our expected OMO purchases of Rs1200bn/US$25bn.

■ … and softer lending rates should support loan demand
There is also greater visibility of our expected 50-100bp bank prime lending rate (PLR) cut by September. A much more politically stable Delhi should be able to muster the comfort to cut PSU bank deposit rates, if CPI inflation softens as we forecast. This, in turn, should fructify our expected bottoming out of credit demand around 15.5% (14%, earlier) by September to fund end-09 recovery.

■ With 550bp PLR-10y spread muting fiscal/inflation risks…
Won’t a high fiscal deficit/inflation prevent softer lending rates? Not really. True, we ourselves expect a reversal of the easy money policy by April 10, with WPI inflation crossing 5% by March. Yet, even if yields react – as we expect - the ~550bp spread between bank PLR and the 10y is too high to sustain. This should protect our soft lending rate regime until 2HFY11.

■ …improved BoP outlook easing funding constraints
We have upgraded our FY10 capital inflow projections by US$14bn on a mix of receding international risk aversion as well as domestic political risks. This, in turn, should ease funding constraints given India’s dependence on foreign capital inflows for long-tenor funding. Could appreciation damage recovery? We think not. The RBI will persist, in our view, with its policy preference for a relatively weak INR to support exports. At the same time, the need to block imported inflation from rising oil prices should prevent policy-driven depreciation.

To see full report: ECONOMICS