Transport services have picked up, mining still volatile, says Morgan Stanley Chief India Economist

Upasana Chachra, Chief India Economist, Morgan Stanley

The Reserve Bank of India will start cutting rates from Q1 CY24 — that’s Morgan Stanley’s base case. But, the faster pace at which inflation is moderating, oil prices cooling off and the pick-up in private projects, are factors indicating there may be an earlier start to the rate-cut cycle.

“High-frequency food and cereal prices, which had created an upside in January and February CPI inflation numbers, have all reversed,” Morgan Stanley’s chief India economist Upasana Chachra said in a conversation with Moneycontrol.

Edited excerpts:

Your report says private project execution is at an all-time high. What are the factors indicating this and which sectors are leading the way?
Private projects under implementation and new investments announced by private companies — both have been improving over the past few quarters now. Though the growth is coming from a low base, implementation of private sector projects is faring better than public ones.

Balance sheet positions for private corporate and financial sector companies are also very strong. Plus, the capacity utilisation rate is currently higher than the long-term average. These data points give us confidence that the green shoots on the private capex side will sustain.

The manufacturing space has been leading the way over the past one year and we see the momentum sustaining. In the last quarter, there was an improvement in the services sector, particularly transport services. This means road and rail activity has seen a pronounced uptick. Construction, which includes steel and cement, is doing fairly fine. On the other hand, mining and electricity has been more volatile.

Also Read: Retail prices offer a breather to RBI as inflation drops to 15-month low of 5.66%

What is the sense you are getting from corporates?From a domestic perspective, we see hardly any roadblocks to the capex recovery cycle. Business sentiment indicators have improved, corporate debt remains at a 16-year low, the financial sector’s non-performing assets are at 11-year lows. So, there is a demand and also supply to fund this capex cycle.

Talking of demand, how is rural demand picking up? If wages are higher and employment demand is lower, why are FMCG companies still not seeing volume growth?
The services sector, which employs many from the rural areas, started operating at full capacity only from April 2022. This means livelihoods have been restored but household balance sheets are still healing from the two years of massive disruption.

The situation is evenly placed at the moment. The impact of El Nino on the summer crop output needs to be watched. Barring that risk, I expect rural demand will show more decisive signs of a recovery rather than the patchy signs now.

Subsidy spending is being reduced while there are talks of increased incentives ahead of general elections. How will the fiscal deficit be managed?
At the moment, we are working with the government's estimate for the fiscal deficit, i.e., 5.9 percent for FY24. With the assumption that tax-to-GDP revenue remains steady, the government will get to spend more on the capex side.

Elections always create a narrative around incentives. But apart from PM-Kisan, past instances do not indicate any such trend. I would say it looks like a low-probability event.

Unless, there is some sort of risk of a global recession, then fiscal support might come in, but that too will be targeted and specific. I don’t think we will need any large-scale fiscal stimulus to support the economy.

Also Read: Capex cannot be driven largely by public investment: Assocham

Isn't inflation below 6 percent largely because of the base effect? Why do you see RBI cutting rates sooner then?
The possibility of a rate cut cycle beginning sooner than we expect is not being driven by just the base effect. The downside risk comes more from sequential moderation in inflation, which has been driven by lower-than-expected oil prices. At the same time, high-frequency food and cereal prices, which had created an upside in January and February CPI inflation numbers, have all reversed. Since the food basket has a big share in headline inflation, the overall outlook is improving.

Our base case is that inflation will average around 5.5 percent in FY24 and below 5 percent in FY25. Therefore, we think the RBI can start with a very shallow rate cut cycle — 25 basis points in March 2024 and another 25 in June.

Do you think the RBI should continue with the pause in rates if the Fed continues to raise?
First, inflation numbers are definitely going to be lower than what they were when the RBI MPC met in April. Second, the external balance sheet is looking better because the current account deficit is being supported by the services trade balance. Since commodity prices have cooled off, the commodity trade balance is also coming off. That means net-net the current account deficit is expected to be below 2 percent of GDP in FY24. Thus, pressure on the currency perspective will also be lower. Third, the RBI has an FY24 GDP growth projection of 6.5 percent.

So, we believe rates have topped out and the current repo rate of 6.5 percent is the terminal repo rate.

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