May 03, 2012, 04.31 PM IST | Source: CNBC-TV18

RBI may ease rates by only 25 bps by year-end: Nomura

India's manufacturing sector grew slightly in April on the back of new orders, an HSBC survey said. Experts feel that growth has bottomed out led largely by domestic and export manufacturing.

India's manufacturing sector grew slightly in April on the back of new orders, an HSBC survey said. Experts feel that growth has bottomed out led largely by domestic and export manufacturing.

However, Sonal Varma of Nomura points out that the only issue in the PMI numbers is that the inflation pressures also seem to be resulting, so we need to keep an eye out on inflation.

In an interview to CNBC-TV18, she said, "Headline inflation will remain around 7% or so whereas the composition of inflation will change. Input cost pressures such as fuel prices, food prices will start moving higher but core inflation which is driven more by demand side pressures and also how the non-oil commodity basket is moving will continue to drop

At the same time, Verma says that bulk of monetary easing is behind us and the central bank may cut rates by another 25 basis points (bps) only by year-end. Reserve Bank of India's scope of cutting rates further is limited, she pointed out.

Here is an edited transcript of her comments. Also watch the accompanying video.

Q: What you read into the Purchasing Managers’ Index (PMI) data that has been coming out through this week and whether you see any signs of improvement, at least in terms of manufacturing or other core numbers?

A: The takeaway is that activity has bottomed out, so we are seeing some pickup in the manufacturing PMI numbers. There has been a pickup in new domestic orders. Hence, domestically demand is picking up and we have also seen a pickup in new export orders.

The margin growth has bottomed out largely due to domestic manufacturing doing better and exports picking up. The only issue in the PMI numbers yesterday is that the inflation pressures also seem to be resulting at the same time. We need to keep an eye on inflation.

Q: How would you put that over the next few months, what it is that you expect to see on inflation and how sharp you think this recovery in terms of inflation rates itself is going to be?

A: I think next few months is going to be a slightly mixed, specifically the month of April. In the Wholesale Price Index (WPI), we are going to see a pickup in both the headline as well as the core WPI manufactured products.

Looking beyond the April reading, our view is that headline inflation will remain around 7% or so. Whereas the composition of inflation will change, so input cost pressures such as fuel prices, food prices will start moving higher.

But, core inflation which is driven more by demand side pressures and also how the non-oil commodity basket is moving will continue to drop. We are expecting core inflation to drop but headline inflation to remain around the current levels. From the rates perspective, beyond 50 bps that the RBI has delivered, we are expecting one more rate cut towards the second half.

Q: What would the quantum of that cut be because some of your peers are suggesting there is very little scope for the RBI to move any more and the context of their note the last time around seem to suggest that its 50 bps and no more from us?

A: We are expecting one more 25 bps and nothing beyond that. One more because we think core inflation will decline towards the end of the year but, from a more medium-term perspective, RBI has limited scope.

Inflation is not falling below 7%, CPI numbers are above 8%, current account deficit is at 4% of GDP and at this stage the scope for RBI to provide any significant monetary stimulus does not exist. So, in our view, bulk of the rate cuts have happened.

Q: What do you expect to see over the course of the next six months or so? What remains your prime worry, considering the fact that growth will not recover on the pace we are expecting, that inflation will rear its head again or just that the situation will remain very clamped down in rates and what happens in terms of a flow through to the system because we have seen what’s happened with the 50 bps rate cut nothing has happened actually with the banks?

A: If we are so worried about growth, I don’t think inflation should tremendously rear its head up unless global commodity prices move higher. And growth in our view was 6% or so in the December quarter, which was at the bottom.

We would expect some gradual recovery on the growth front also. But, our key concern at this stage is what after this, unless quick decisions are taken by the government to address its structural fiscal deficit.

The governance deficit will be stuck in this 7-7.5% range for quite some time and breaking out of this range and going back to 8-8.5% kind of a sustainable growth regime will be difficult in this current macro environment. That is more worrisome.

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