India Business Forecast Report Q4 2009

Macroeconomic Stability At Risk The unexpectedly strong mandate given to the ruling United Progressive Alliance government in the April-May national elections is a considerable positive for political stability and the potential for economic reform. Nonetheless, the new government faces a daunting task in supporting the economy, boosting domestic security and improving relations with Pakistan and the US. We therefore believe that hopes for more ambitious economic reform measures are likely to be frustrated in the short term. Indeed, the immediate focus of the government will be to support domestic demand and economic activity. The strong fiscal stimulus in the FY2009/10 (April-March) budget contributed to our decision to revise up our GDP growth forecast for the year from 5.0% to 6.1%.

We see potential for India to benefit greatly from the strong mandate given to ruling United Progressive Alliance (UPA) government in the April-May national elections. Indeed, the Indian National Congress (INC), which was previously hostage to support parties within and outside of the UPA coalition, now has the opportunity to implement the economic reform agenda of Prime Minister Manmohan Singh. However, more immediate priorities such as the implementation and subsequent rollback of fiscal stimulus measures, the need to enforce government control in Naxalite rebel-controlled areas and to manage relations with Pakistan and the US, will most likely take precedence in the short term.

We are expecting the election result and an improved global outlook to have a positive impact on private consumption and fixed capital investment and have therefore revised up our GDP growth forecast for FY2009/10 (April-March) from 5.0% to 6.1%. However, while strong fiscal and monetary stimulus will bolster growth in FY09/10 it has created risks for India's credit rating and inflation expectations in the medium-to-long term. We expect the government and central bank to start rolling back their stimulus measures once convincing evidence emerges that the domestic and global economy are on a better footing. As a consequence, we have kept our 6.4% GDP growth forecast for FY2010/2011 unchanged.

We maintain that without more substantial improvements to India's rudimentary infrastructure, it will not be able to achieve annual GDP growth of 8-9%, as targeted. The budget for FY2009/10 (April-March) earmarks a significant amount of spending on rural infrastructure, but we believe public investment in education and infrastructure will fall well short of India's immense needs.

Nonetheless, we see potential for an increase in public-private partnerships (PPP), which have shown some initial success. However, we do not believe that India has, or for that matter, will have any time soon, the required policy and regulatory framework to double the degree of annual infrastructure investment from 4.5% to 9.0% of GDP over the next five years as targeted