By Lakshmi Iyer
The Indian economy is slowing down. The Q2 GDP growth rate at 4.5% amply indicates that industrial activity may be coming to a halt. This growth rate has largely been due to social spends and government activity, else the numbers would have been even bleaker.
Thus, growth has become an imperative over inflation at the current juncture. On the other hand, the fiscal slippage is a real concern for the market. The government deficit for the April-October period has already exceeded 102 per cent of the annual target, and we still have five more months to go. In this backdrop, the market believes more rate cuts are in the offing.
High real rates may have raised the cost of the capital for entrepreneurs in real terms and moderating private sector expenditure and low inflation offer little incentive to invest. Therefore, consensus is building that the repo rate cut cycle may have more steam left in it.
Having said that, the fiscal deficit slippage and the borrowing scale may remain a cause of worry for the market and may cause it to trend in the narrow range. The liquidity is in surplus, but it is yet to fully reflect on the market yield levels.
Apart from that, talks of including India into the JPMorgan EM Bond Index is also a huge positive. It will let Indian bonds become a part of investment portfolio of global investment funds and, thus, increase FPI appetite for Indian debt. The timeline and the proportion for this remain to be seen.
FPIs simply cannot ignore the high real rates that Indian bonds have to offer – one of the highest in the world. Additionally, the world over, interest rates are on the decline. In fact, the US has been effecting insurance rate cuts to ensure that no stone is left unturned to revive growth prospects.
The key risks, from our point of view, are the fiscal slippage, any agri-sector supply shock and rising populist spending by government(s). From that point of view, the wordings of RBI’s money policy would be a key guidance for market sentiment if it gives enough indication on how the government aims to handle these potential factors.
Clarity on fiscal issue or on disinvestment would be a much awaited item. The bottomline is that the MPC could be caught between the devil and the deep sea, as lower GDP growth data collides with a rise in recent inflation (CPI), but it may still choose to fan growth concerns and gratify markets with a repo rate cut.
(Lakshmi Iyer is CIO for Debt and Head of Products at Kotak Mahindra Asset Management Company)
Source: Economic Times