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Why Morgan Stanley is upbeat about the Indian economy

Source: PTI
April 06, 2015 18:18 IST

A stock traderPredicting an average sub-5 per cent inflation this year, Morgan Stanley has said India is in for a long period of higher sustainable growth and lower prices.

"We are more constructive on inflation outlook and we expect the retail price index to decelerate to 4.75 per cent by this December against the consensus estimate of 5.8 per cent.

“We also expect growth momentum to pick up, but do not expect a rise in inflationary pressure," says Chetan Ahya of Morgan Stanley in a note.

He also notes that rural wage growth has come down to a nine-year low of 5.5 per cent in January this year from a steep 20 per cent in FY 2013.

Morgan Stanley draws optimism from a slew of favourable factors, which influence retail inflation trend, such as wage growth, fiscal policy, growth-mix, real interest rates and global commodity prices.

The last time inflation and growth moved in tandem was 2003-05, paving the way for near double digit growth before recession played spoilsport.

"Comparing the drivers of inflation between the two cycles we see that domestic factors are moving along similar lines as in the 2003-05 cycle and decline in global commodity prices are an added support in the current cycle," Ahya said.

Stating that sustained inflation deceleration will provide more room for more monetary easing, he forecast a sustainability lower inflation path of 5 per cent to be achieved from April, and expects inflation to decelerate to 4.75 per cent by December this year.

"Based on our expectation of the inflation trajectory, we believe the Reserve Bank could lower rates by a further 75-100 basis points in 2015.

“Also we believe deposit rates are to decline significantly and more than policy rates."

Comparing the current inflation-growth cycle to the 2003-05 cycle and citing the present domestic and external macro environments, Ahya said, ‘like in the current period, the economy was in the early stage of recovery between 2003 and 2005.

‘In the previous cycle acceleration in growth was accompanied by significant improvement in productivity which kept inflation low and stable."

Citing parallels with FY 2003-05 period, he recalled that driven by heavy investment in infrastructure by government and a private sector capex spree, coupled with low inflation the country saw higher growth rates during FY 2003-05.

While growth scaled past 9 per cent, and averaged at 7.9 per cent, inflation remained stable and low averaging at 4 per cent--with food inflation averaging 3.2 per cent and non-food inflation averaging 4.5 per cent.

This higher growth was driven by capex, which did not create excess inflationary pressure, said Ahya, adding growth accelerated from around 4.6 per cent in FY 2002 to 9.2 per cent in FY 2005 and capex as a percentage of GDP rose from 24.8 per cent in FY 2003 to 34.7 per cent in FY 2006, while CPI inflation remained range-bound.

"This was possible as acceleration in growth was accompanied by significant improvement in overall productivity," Ahya said.

It can be recalled that CPI inflation, which stood at 5.4 per cent in February, has been steadily declining over the past 10 months after a period of nearly five years that has seen an elevated level of CPI inflation at around 10 per cent.

Ruling out wage-driven inflation, as happened during FY 2008-13, he said considering the large addition to the workforce every year, wage growth as such has traditionally not been in a key factor causing inflationary pressures.

Between 2003 and 2005, he said, rural wage growth remained steady in a range of 3-7 per cent and averaged around 3 per cent.

This was lower than nominal farm gross domestic product growth of around 8 per cent and thus ensured that rural wage growth did not lead to any inflationary pressures from the demand or cost side.

Image: A stock trader; Photograph: Reuters

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