Nomura India expects another 50 bps hike in policy rates

Nomura Financial Advisory & Securities expects another 50 bps hike in policy rates.

"In the coming quarters we expect inflation to remain high and growth to remain around the RBI's baseline projection of 8%, prompting another 50 bps hike in policy rates," Nomura Financial Advisory & Securities India economist, Sonal Varma told reporters.

With less scope for proceeds from asset sales and a higher subsidy burden, we expect the Government's fiscal deficit to rise to 5.2% of GDP in FY12 higher than the government's 4.6% of GDP target.

The RBI hiked policy rates by 50 bps in May, deviating from its calibrated approach. From its trough, the RBI has hiked the repo rate by 250 bps this cycle.

Varma expects the real GDP growth rate of fall below 8% in the coming quarters, owing to increased margin pressure on manufacturers, adverse base effects and lagged effects of policy tightening.

With substantial effective policy tightening in place, risks to domestic demand have risen. We expect real GDP growth to remain trend growth of 8% in 2011 and 2012 as compared to an above-trend 8.8% in 2010, she said.

Despite an effective policy tightening of 350 bps and a drop in food inflation from a peak of 20% YoY in February 2010 to 6.8%, headline wholesale price index (WPI) inflation has remained stubbornly high.

There are many reasons behind the slowdown in economic momentum.

The acceleration caused by inventory restocking and pent up demand is fading, financial conditions have tightened substantially, owning to tight domestic liquidity, high inflation is squeezing firms profit margins and Government decision-making has slowed due to numerous scams and scandals.

However, we expect buoyancy in services such as wholesale and retail trading, hotels, transportation, communication and financing and business services to be well supported by strong external and domestic consumption demand.

There is still a chance that Government decision-making accelerates once state elections in May and a cabinet reshuffle in May/June is completed, Varma said.

Varma pointed out that the FDI inflows have slumped because of both global and local factors. However, India remains an attractive investment destination and we expect flows to return to a pre-crisis peak by early 2010.