A sharp global slowdown would weaken exports of both goods and services, but the larger impact on India would be through the secondary channels of net capital outflows, tighter financing conditions, falling confidence and negative wealth effects. With the domestic economy already in a cyclical downturn, worsening global growth will slow real GDP growth to 7.0% y-o-y in 2011, instead of 7.7% in our base case. Meanwhile, a 15% correction in global commodity prices will lower WPI inflation to around 7% y-o-y by December 2011, in line with the RBI‟s March 2012 projection.

India‟s consolidated public debt at close to 70% of GDP does not leave much scope for additional fiscal stimulus, as a slowdown can hurt revenues more than the benefit from lower subsidies. However, there is substantial room for a monetary policy response. With repo rates at 8%, the highest since May 2008, the RBI will likely keep the repo rate on hold in September and could cut policy rates thereafter. With FX reserves at USD286bn, the RBI has enough of a cushion to defend INR, but FX intervention would likely drain INR liquidity. We believe that cutting the cash reserve ratio (CRR) would be the RBI‟s first course of action, followed by open market operations in order to inject INR liquidity.