BofA-ML's four key factors to track for economic recovery

NEW DELHI: Post the Gross Domestic Product (GDP) growth numbers coming in at 4.8% for the fourth quarter of FY13, Bank of America Merrill Lynch (BofA-ML) has reiterated its opinion that the economic growth has bottomed out.

The bank sees a shallow recovery in the second half of the current financial year. However, with tight liquidity delaying lending rate cuts, the bank has marginally cut growth forecasts to 5.8% (from 6%) in FY14 and 6.8% (from 7.2%) in FY15.

In his latest report Indranil Sen Gupta, India Economist at DSP Merrill Lynch (India) has highlighted the key factors that investors should watch out for, to get a direction on the possible growth trajectory of the economy.

How badly is India doing?

According to the bank, India is performing in line with other BRICs, all of which are seeing a relatively long bottoming.

"In fact, India's inflation, at 1.2x of growth, is actually better than Brazil's 2.8x and Russia's 1.7x," the bank said. It is for this reason that 80% of the investors the bank met have turned - albeit, reluctantly - neutral-to-overweight on India to diversify risk out of China, says Sen Gupta.

Lending rate cuts enough?

The major question that investors are worrying about is, will lending rate cuts be sufficient to drive recovery unless capex picks up? "Lending rate cuts, at least, can take growth back to 6% levels," says the bank.

The bank estimates that the 300bp slowdown in growth in the past 3 years can be decomposed into global downturn (150bp), RBI tightening (75bp), investment slowdown (50bp) and poor rains (25bp).

"Given that neither the global business cycle is likely to turn nor capex set to turn around, recovery will pretty much depend on rains and lending rate cuts," Sen Gupta says.

The bank continues to remain bearish on capex till the summer 2014 polls are over and the global business cycle bottoms out. "While it is conventional wisdom to mourn 'national' impediments - such as delays in environmental clearances, lack of reforms in land acquisition etc - the fact is that capex has slowed across all BRICs due to the global downturn," the bank says.

"Although it is fashionable to lament that lack of reforms is pushing up the incremental capital-output ratio, a measure of capital inefficiency, (to 6.6 from 3.5 during the upcycle), the fact is ICOR is rising across BRICs as the global downturn is delaying investment. In sum, although recent government initiatives are certainly welcome, capex is unlikely to recover until the global business cycle turns around - which we expect in 2015," it adds.

Lead for recovery? Lending rate cuts!

The bank's lead indicators have - correctly - signaled worst over for a year. "At the same time, the All Clear can only sound when loan demand bottoms. This, in turn, can only happen when lending rates come off," Sen Gupta says.

"Experience suggests that the Indian cycle will turn up (down) when the real lending rate, now 7.25%, slips below (pierces) the 7.5% potential. We continue to expect lending rates to come off another 50-75bp by March 2014 atop the 50-75bp so far," the bank says.