[T.S.R:15875] CLSA: Are $28 Bn Worth of Gold Imports Distorting the Current A/C Deficit?

CLSA India: Positives Far Exceed The Apparent Negatives   One important factor that is being largely ignored when discussing the widening trade deficit and CA deficit is the impact of rising price of gold. India is the world's last market for gold, and imported USD 28.0bn of gold in 2009-10 (to put the size of gold import in context, the CA deficit was USD38.4bn in that year).   Gold accounts for around 10% of total imports and should be treated differently from, say, an LCD TV or crude oil import, as gold is essentially an asset and store of value and hence does not "disappear" once it is consumed. However, gold imports affect the CA balance although a sizeable portion of gold is for investment, which better fits a capital account transaction.   Thus, the structural CA deficit is lower than what the official figures suggest over and above the gold used for jewellery that is exported.   India's macro setting appeared relatively more attractive in the current global backdrop of lowfor-longer growth and interest rates, and easy liquidity. Indeed, India remains a supply constrained economy that will need to attract capital inflows to complement domestic resources to fund its economic expansion.   And the current combination of weak growth and ample liquidity provides an attractive backdrop for the Indian economy and asset prices.  Growth outlook: We remain comfortable with our GDP growth forecast of 8.5% in 2010-11, and investors appear to have now pretty much discounted this outcome. A good monsoon is likely to power agriculture growth to around 6.0%, and will underscore the economic rebound by boosting rural demand. There is a slight scope of an upside surprise on our GDP growth forecast but given the rolling over in economic activity that is palpable and the global risk factors, we are not keen to make a marginal upward revision to our forecast.   Further, as explained in detail in the 4Q10 EoAE Viewpoint -Resurgent India: Putting on muscle, we expect India's economic growth to hit 9.0% in 2011-2012 after a slight moderation next year owing to softening global demand. We also expect the investment upturn to gain more traction.   However, few investors are convinced about the economy growing at 9.0% annually within the next 2-3 years.   Inflation and monetary policy: The inflation outlook prompted a mixed response. Not all investors are on board with our view that the RBI is nearing a pause setting. We maintain that the RBI is on track to achieve its WPI inflation forecast of 6.0% by March 2011.   The magnitude of increase in global commodity prices is a key risk to this view. However, domestically, food inflation, which has been worsened by distribution-related disruptions owing to heavy rainfall and flooding in some areas, should ease as the new harvest comes to the market.   We maintain that the RBI is likely to stay on hold at its 2 November policy review, but bear in mind that it is not done with tightening in the current cycle (unless the global backdrop worsens significantly).  Balance of payments: The widening CA deficit was a common concern among investors for two reasons: (1) India is increasingly more reliant on portfolio inflows for its CA financing; and (2) there is a perception that the worsening in CA deficit is due mainly to the consumption boom currently under way rather than an investment upturn.   The financing issue is a legitimate concern and the government should further speed up the opening up of sectors so as to make foreign direct investment more attractive and thus make the overall capital inflows less volatile. The recent hike in FII limit in local currency debt should be seen in the context of an attempt to diversify the nature of capital inflows.   Indian policymakers have preferred to maintain an elevated growth trajectory at a time when global growth is down in the dumps, thereby showing their willingness to live with a wider CA deficit. The alternative is to have greater volatility in the economic cycle, which has never been a sought after strategy.   Given that India is starved of capital, the wider CA deficit also indicates the increased absorptive capacity of the economy in digesting foreign capital inflows. The increase in absorptive capacity could be even greater if the government were able to speed up the implementation of infrastructure-related project work that would further enhance the limit of non-inflationary economic growth.  There is a misperception among investors that India's savings rate has declined because a consumption boom is underway, and that consumption boom is mainly responsible for the worsening of the CA deficit.   A key challenge to these views is that there are no data to conclusively support these claims. India reports the details of its external trade by products with a significant lag, and hence they cannot be used to cross check.   However, note that India has a significant pent up demand for consumer durables, and that demand is boosted by ongoing the demographic transition that increases the number of people with improving affordability.    In our view, it is more likely to be the case that the savings rate has increased but that the investment rate has increased even more, thereby widening the CA deficit. Indeed, a consumption boom and a rising savings rate are not mutually exclusive in an economy that is undergoing structural changes.   Safe Harbor Statement: Some forward looking statements on projections, estimates, expectations & outlook are included to enable a better comprehension of the Company prospects. Actual results may, however, differ materially from those stated on account of factors such as changes in government regulations, tax regimes, economic developments within India and the countries within which the Company conducts its business, exchange rate and interest rate movements, impact of competing products and their pricing, product demand and supply constraints.   Nothing in this article is, or should be construed as, investment advice.

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