5 reasons why a ratings upgrade may be coming India's way

Moneycontrol Bureau

Global rating agency Moody's Investors Service has warned Brazil of a credit rating downgrade in the next couple of years on economic slowdown. Will this have a bearing on outlook of other emerging markets? Certaintly not for India, says Bank of America Merrill Lynch (BofAML). In its recent report titled ‘India Economic Watch’, the research firm highlights five factors which should get an outlook upgrade for India sooner than later. Infact it adds that the April 2012 outlook downgrade by Standard & Poors (S&P) was unwarranted.

According to BofAML, India's growth is bottoming out far higher than Brazil or Russia, and this puts to rest concerns about falling potential. If Modi government steps up infrastructure investment then it expects India to rebound to 7.5 percent by 2018. Secondly, drivers of inflation are fading also narrowing rainfall deficit, surge in inflation may not last longer. Thirdly, risks arising from current account and fiscal deficit have proven to be overdone. Fourth, RBI governor Raghuram Rajan is recouping forex reserves. Finally, this should allow the RBI to cut rates from February onwards even if the Fed hikes, it says.

Also Read: Eco prospects brighten, see GDP at 5.2percent in 2014, says Moody's

Excerpts from the report

Growth bottoming out: 5.5percent FY15, 6.5percent FY16, 7.5percent FY18

Our growth is bottoming out far higher than Brazil or Russia. This is why we always found concern that India would fall out of BRICs in 2012 to be baseless. In fact, we believe India should emerge as the second-largest EM after China by 2019. We continue to reiterate our standing view that India's potential growth is about 7.5percent .

Inflation peaking off: 8.5 percent August, but 6 percent in 2016

We think that inflation is peaking. Although we have higher-than consensusinflation forecasts (8.5 percent in August, 7.8 percent consensus; 8 percent in July, 7.4 percent consensus, 8 percent actual), this is driven by a temporary spike in tomato prices on poor rains. This will reverse with the seasonal rainfall deficit down to 11 percent of normal. This leads us to expect the first RBI rate cut in February. We expect CPI inflation to come off to 6percent in 2016 in line with the RBI's forecast.

Twin deficit risks overdone

Risks from twin deficits have proved overdone. The current account deficit should compress to 1.7percent of GDP in FY15 from 4.8percent of GDP in FY13, partly on gold import curbs. While we expect the current account deficit to expand to 2.4percent next year after the inevitable removal of gold import restrictions, this would be still in line with our optimal estimate of about 2.4percent . This supports our view that the current account deficit was statistically overestimated in FY13.

RBI to buy FX to guard against contagion; hold Rs 58- 62/USD

We continue to expect Governor Rajan to buy FX‒ at Rs58+/USD‒ to guardagainst contagion as Governors Jalan and Reddy did. This is reversing the policymistake of completely unsustainable appreciation by stopping to buy FX reserves in 2H09-1H11. As import cover plummeted, that led to 50percent depreciation later. This will likely stabilize Rs58-62/USD. We expect RBI to buy US$35-40bn by March 2016 to maintain 8-month import cover.

RBI to cut rates even if Fed hikes; 75bp cut February onwards

We believe that the RBI can cut rates even if the Fed hikes from September 2015, with Governor Rajan recouping FX reserves. We see it cutting policy rates by 75-100bp starting in February, even if Fed Chair Janet Yellen hikes from September 2015, as our US economists expect.