Risks to Complete Recovery of Economy

India’s biggest macro risk is a second successive drought that would push the economy off the global recovery track. This would likely pull FY11 growth down to 5.5% levels from our normal-rains base case 7.7%.The direct hit on the harvest would be reinforced by shrinkage in rural demand as incomes fall again. Besides, the RBI would likely be forced to tighten to anchor 5% inflation expectations as depleting buffer food stocks would fire up agflation. In the double drought of 1987-88, India had also slipped behind the global recovery of the time.

Crude OIL @ USD 120 / barrel – A rising oil import bill and portfolio outflows to oil producers would likely push India’s import cover (ie, months of imports fundable by fx reserves) to single digit for the first time in 10 years. This, in turn, would limit the RBI’s ability to buy oil bonds from oil refiners and neutralize the monetary impact by releasing fx to fund higher oil imports.

Double Dip May Hurt – India is at a relative advantage clocking 6% growth in FY11-12 if the rains are normal. That said, we do not expect, let us be clear, a double dip. Even if a “W” does materialize, the growth impact of falling external demand should be restricted to 150bp on the demand side as exports are but 18% of GDP. India is dependent on foreign capital for project finance of 3-4% of GDP and this could hit the growth to minor extent.