>INDIA WEEK AHEAD (MERRILL LYNCH)

Raining trouble: 50bp growth drying up

■ Met expects monsoon to shower the Ganga…
We hope that the monsoon continues to water the north-east Ganga rice bowl as the Met expects. The good news: the critical July sowing month saw normal 90+% rains, far better than the drought years of FY88 (71%) and FY03 (51%). Besides, rains finally reached the Ganga last week. The bad news: time’s running out, with seasonal deficiency still 19%, albeit much improved from 54% a month ago (Chart 1 and Table 2).

■ … but dismal 25% lower rice cropping to hit growth 50bp
Let’s face it, while we will wait a week, it looks virtually impossible to recoup rice cultivation – now 25% below last year (Table 3). The sowing calendar is already stretched (Table 4) in UP, Bihar and West Bengal that account for ~30% of the rice crop (Table 5). Yes, rice is but ~1% of GDP, but a ~20% contraction will likely hit growth ~50bp, after second-round effects. The relief is that recovery in other crops should prevent the catastrophic 7% drop in agro growth drought 2002 saw.

■ Inflation risks rising, but food price spike overdone
We continue to expect inflation – (-)1.6% Thursday – to harden to 6.5% by March (Chart 2 and Table 6). Besides, poor rains pose 150bp upside risk (Table 7), even if rice prices are contained by the large 19.6mt stock, double the July 9.6mt buffer stock norm. We, however, do not expect the current essentially speculative spike in food prices - rice (25%), pulses (40%), onions and potatoes (50%) – to sustain. Improvement in cropping (in case of pulses) and as-usual-belated government action should dampen “hoarding”.

■ Monsoon liquidity to damp fiscal pressures…
We continue to expect ~US$25bn seasonal liquidity and the 350+bp 10y-RBI policy rate spread to continue to cushion government borrowing (~Rs3200bn/ US$68bn, net of RBI OMO/MSS in FY10). This should keep yields in a trading range for now. At the same time, we have grown more confident of our January/ April RBI hike call, after Gov Subbarao’s relatively hawkish monetary policy last Tuesday (Chart 3). We continue to expect upside pressure on yields by March.


■ … fx flows to turn on risk, NHPC; RBI to support exports
We expect FII inflows to swing to risk appetite expansionary 50+ PMI & the NHPC IPO, kicking off divestment. Earnings, after all,are more or less,out of the way, without any major disappointment. Successful divestment ,~Rs120bn BASMLe , should alleviate crowding out fears; which, in any case, we find overdone here. We continue to expect RBI intervention to curtail appreciation to protect exports (and recoup fx reserves) for now. Commerce minister Anand Sharma has already disclosed that June 09 exports will still show a large 29% y-o-y drop
Monday. At the same time, this, in no way, detracts from our long-held twin view of BoP risks overdone/ constructive INR outlook.

To see full report: WEEK AHEAD