Yes Bank India Macro Quarterly - Correcting Macroeconomic Imbalances

“INDIA MACRO QUARTERLY - Correcting Macroeconomic Imbalances” by YES BANK. The reports gives out detailed insights & aspects on Macroeconomic imbalances & how it could be corrected. I feel it is a strong aspect that can be presented through your esteem publication. Request you to consider our submission for your publication.

Synopsis: After a volatility ridden experience in FY14, domestic macros are set for a moderate improvement in FY15. Investment revival and moderation in structural inflation pressures are likely to play out as a theme over the next 2-3 years. While monetary policy is likely to be in a state of extended pause, fiscal policy and governance are expected to play an important role over the next 2-3 years. Our latest quarterly report takes stock of these changing dynamics and outlines our expectations on key macros.

CONTENTS

FY15 GDP: Reforming for a strong and balanced growth recovery

Growth has remained sub 5% over the last two years owing to adverse spillovers from cyclical as well as structural; with the stasis being compounded by a feeble global economic recovery. We see cycical recovery taking shape led by improvement in investments and exports. However for growth to turn stronger and balanced, structural reforms are the solution. Our analysis indicates that government policy action on rationalizing subsidies and easing business regulations can help to quicken pace of growth recovery. The new Government in its early days has demonstrated its intent on the shape of these economic reforms, but will have to move quickly within the political and legislative system with States on board, to affect the requisite changes in order to ease supply constraints and propel growth.

Inflation: Structural dynamics to enable inflation to glide lower

Structural factors and elevated fiscal deficit that contributed to high inflation, have begun to correct, paving way for moderation in inflationary pressures. Yet, short term risks like higher food prices and oil price rise due to geo-political stress has potential to disrupt the disinflationary process on account of ease in structural drivers. Nevertheless, we expect CPI inflation to moderate towards 7.5%-8.0% by Jan-15. However, in order to attain the 6% CPI target, there is urgent need for the government to overhaul the food economy in absence of which the onus of controlling inflation would unduly fall on monetary policy.

Looking forward: Improving the growth-inflation tradeoff

With growth showing early signs of revival and price pressures moderating somewhat on trend, the question arises as to how the growth-inflation balance will evolve over FY15-16? The expected revival in growth will be able to curb inflation over longer term if focus is on investments to enhance domestic capacity. Further, there is a need for fiscal policy to consolidate itself responsibly, such that any simulated upside in demand-side inflation is averted.

Fiscal support to growth-inflation balance

Despite pockets of apprehensions, we believe FY15 fiscal deficit target of 4.1% of GDP is achievable. The fiscal stance adopted by the new government is likely to lead to a gradual improvement in the growth-inflation balance through emphasis on investment revival and improvement in quality of expenditure. From a market's perspective, the borrowing requirement will be neutral. However, front loading of expenditure vis-a-vis revenue could lead to a buildup of government's surplus cash balances with the RBI resulting in frictional stress in money market liquidity in H2 FY15.

Rates to gradually drift lower by Q4 FY15

With RBI now focusing on the medium term inflation target of 6% by Jan-16, we expect a prolonged pause on monetary policy with scope for first rate cut in H1 FY16. This along with the likelihood of further cuts in SLR/HTML will keep bond market cautious in the near term with 10Y g-sec yield around 8.55%. However, with inflation moderation becoming durable and supply pressure tapering towards Q4 FY15, we expect yields to drift lower towards 8.30%. Food, oil, and monetary policy normalization in advanced countries will continue to provide upside risk to yields.

External Sector Dynamics: FY15 CAD at 2% and INR at 59 by March 2015

The sharp compression in FY14 CAD changed investor perception about India’s external sector vulnerability. With strong electoral outcome, capital inflows have been strong in FY15 so far. While we expect CAD to increase from 1.7% of GDP to 2.0% in FY15 in line with improvement in growth conditions, the same is likely to be financed easily with a BoP surplus of USD 25 bn. Although INR could trade in the range of 60-62 levels in the near term amidst geopolitical concerns and broadly unchanged REER index, we expect it to strengthen towards 59 levels by Q4 FY15 on the back of gradual improvement in growth-inflation balance and further progress towards quality fiscal consolidation in FY16. Positive bias, however, is expected to be marginal due to anticipated volatility associated with the first rate hike from the US Fed in 2015.