With the fiscal and current account deficits running high and inflation remaining sticky, the “space for rate cuts” continues to be limited, according to a report by Nomura International (HK) Ltd.
It also expects the Indian government to present a “balanced” Budget next year, which would be the last regular Budget ahead of the Lok Sabha polls in 2014, in the context of the threat of a rating downgrade.
In its “Asia Special Report” dated November 28, Nomura said despite the recent reforms that perked up markets, the fiscal correction might just remain on paper and hence any recovery in 2013 would be “shallow”.
This was because many negative factors such as supply-side constraints, sticky inflation and weak exports would keep the rupee under pressure. This would hold inflation at elevated levels, limiting room for interest rate cuts.
Holding lack of investment and falling capital productivity as being responsible for the slowdown, Nomura said the slow land/environment clearances contributed to delay in project execution, and to cost escalation. It expects the formation of the National Investment Board and faster clearances to remove the bottlenecks. But any take-off in investments would be a long-drawn affair in the absence of positive triggers such as low inflation, low cost of capital, fiscal consolidation and high global growth.
Nomura also did not expect the consumption story to continue as the Government was running out of fiscal bullets and the persistently high inflation was squeezing purchasing power. It forecast consumption demand to grow 4-5 per cent y-o-y in 2013.
The report said that the threat of a rating downgrade indicates that the GoI will present a balanced budget in February.
Beginning with the Gujarat polls in the next few days, elections are slated in many other states culminating in the Lok Sabha polls in May 2014. As it played the rural employment guarantee scheme and farm-debt waiver cards in 2009 to woo voters, the possibility of the UPA Government resorting to new schemes such as the one revolving around food security or deferring hike in fuel/fertiliser prices could not be ruled out. The probability of this is higher if the verdicts in the state elections go against the UPA government.
Nomura said it expected core inflation to moderate further in the first quarter of 2013, leading to a 50 bps repo rate cut in H1 of 2013. But this window might close in the second half of next year because of inflationary pressures and due to populist measures such as hike in minimum support price for foodgrains and implementation of the Food Security Act. It cautioned that rate cuts in H1 (of 2013) “should not be interpreted as the start of an aggressive rate easing cycle” and said, “this time it is indeed different”.