The QE tapering delay by the US has helped reduce funding risks in the near term in India, a Morgan Stanley Research report said.
Indian funding environment was, to some extent, improved by internal and external factors over the past month, it said.
“Externally, the Fed’s decision to defer the taper of QE and the resulting pullback in US 10-year bond yields helped reduce the pressure on real rates and FX,” the report said.
“Internally, measures to improve the current account deficit via quantitative controls on gold imports and measures to augment capital inflows through NRI (non-resident Indian) deposits have helped to reduce near-term external funding concerns,” said the report released at the Morgan Stanley annual Singapore conference held 13-15 November 2013.
“These developments have helped stabilise the currency and allowed the RBI to remove the monetary tightening measures in a calibrated manner to support (economic) growth, which remains weak,” it said.
Key to risk assets outlook would be the spread of real GDP versus real rates, said the investment bank’s report.
“We believe that the key to India’s macro and risk asset outlook will be the pace of real GDP growth recovery and the trend in real rates for borrowers,” it said.
“On real rates, even as we expect the current account deficit to narrow, it will be difficult for India to cut short-term nominal rates quickly, reverting to a deep negative real rate for savers, unless the US 10-year bond yield also moves back to the levels seen in April 2013,” the report said.
More importantly, considering India’s own domestic imbalances, it will be difficult to bring down short-term rates quickly without a meaningful deceleration in CPI inflation, it added.
On economic growth, the report said: “We believe the most important driver for the growth outlook over the next 6-12 months will be external demand, considering that domestic demand remains constrained.”
“To improve the growth outlook beyond the next 6-12 months, the key would be the government’s policy reformers to reverse distortions in the price of land, labour and capital and to change the expectations of the returns on investment for entrepreneurs by systematically addressing the issues related to the business environment,” it said.
This would help improve the productivity dynamics and bring about an acceleration of GDP growth with the support of a rise in investment to GDP, which would be critical to bring back the virtuous loop of much higher real GDP growth over real interest rates, the report said.
“We believe that for fresh impetus to policy reforms we will need to get the general elections (due in May 2014) out of the way,” said the report.
The report said that a very slow improvement was expected in the trend for real rates for borrowers and real GDP growth.
“For a positive or negative surprise on this outlook, we would watch CPI inflation and exports,” it said.