Investors Jittery Over India's Lack of Real Change on Ground: BofA-ML

Investors Jittery Over India's Lack of Real Change on Ground: BofA-ML
Mumbai: As the Narendra Modi government completes its first year in office, though almost all American investors are 'overweight' on the country, they also complain that nothing is changing on the ground, according to a report by Bank of America-Merrill Lynch.

The US-based brokerage expects Reserve Bank of India Governor Raghuram Rajan to cut policy rates by another 0.25 per cent on June 2 and said that rate cuts and not big-ticket reforms will have a tangible impact on growth.

In the report titled 'Investorspeak: From hope trade to show-me trade', BofA-ML India economist Indranil Sen Gupta said, "We met equity investors in New York and Boston last week. While almost all are overweight on Indian equities, there are indubitable concerns that nothing is really changing on the ground."

On the rate cut, Mr Gupta said, "I expect Rajan to cut (rates by) 25 bps on June 2, pause to allow markets price in the Fed rate hike expected in September, and then cut 50 bps more in early 2016."

Stating that rate cuts rather than reforms are key to cyclical recovery, the brokerage retained banks, other rate sensitives and pharmaceutical stocks as its favourite picks for the year.

"There is greater acceptance of our standing view that the turn in the growth cycle will depend far more on the global economic cycle and lending rate cuts at home rather than reforms," he said, advising investors to focus on reserve money and by extension lending rate cuts, to track the green-shoots.

Stating that the Federal Reserve hike, earnings and Bihar polls will be the biggest swing factors for the market going forward, Mr Gupta underlined that only the RBI can help swing the economy with more rate cuts, and that reforms have not much role to play, negating the argument that investors dumped domestic stocks and debt in the past weeks due to losing steam on the reform front.

Therefore, lending rate cuts can revive demand which in turn will lead to a supply response as low capacity utilisation offers operating leverage.

Rising growth visibility will then lead to higher capex, the report said.

But for the investors, the larger worry is on implementation front, it added.


"Reforms will raise potential growth medium-term and the result will come only in say 5 to 10 years," Mr Gupta said, pointing out that the 1991 reforms lifted potential growth almost 10 years later.

Growth is slowly bottoming out on lending rate cuts as the key leading indicators like real cash demand and risk aversion are both turning around as at the base lending rate of 10.25 per cent the real lending rate is the highest since 1996, he said.

Stating that who rules New Delhi matters less but the health of the global economy matters more for higher growth here, Mr Gupta said, "The Indian growth cycle depends far more on the global growth cycle rather than who rules in New Delhi."

He added that the country will overtake Brazil and Russia in GDP this year to emerge as the second-largest emerging market after China.

Mr Gupta also poured cold water on the hope of huge lifting impact of the GST on GDP, saying "at 27 per cent revenue neutral rate, we feel that markets are over-estimating the benefits of GST".

"Studies show that it will raise GDP by 1-2 per cent over, say 5 years. In other words, it will push up the growth rate by, say, 20-30 bps a year."

On forex reserves, which are ruling at a historic high of over $353 billion as of the past week, he estimates that the RBI will need to buy $59.3 billion in FY16 to maintain a 10-month import cover by March 2016.

Pegging the rupee at 64 to the dollar by September, Mr Gupta said the local unit is over-valued by over 12 per cent against the 36-country REER (real effective exchange rate), which is a better reflection of the value of a currency it is matched against the value of competing units in the export market.

Rising oil prices can scupper many a comfort for the economy, Mr Gupta warned, as a $10/bbl impacts the current account deficit by 0.4 per cent of GDP.