Rains & Rate cuts: BofA-ML's two 'Rs' on which India's economic growth depends

NEW DELHI: In its latest report titled 'India: baby steps to easing', Bank of America Merrill Lynch ( BofA-ML) has said that the country's economic recovery in the coming financial year is dependent on the two 'Rs' of better rains and lending rate cuts.

"Our growth recovery to 6% in FY14 from 5% this fiscal is predicated on the two 'R's: better rains and lending rate cuts. Our economists expect global growth to stagnate at 3% levels," the bank has said.

While the bank feels that investment is unlikely to revive until the 2014 general elections, the government's recent reform initiatives have certainly boosted the sentiment.

On the issue of Reserve Bank of India's (RBI) monetary policy, the report said that the central bank is expected to gradually shift focus to reviving growth. "We expect the RBI to continue to gradually shift focus to reviving growth from exclusively fighting inflation since 2010," the report said. "We continue to highlight that lending rate cuts hold the key to immediate recovery," it added.

RBI may increasingly focus on improving liquidity to pull down interest rates to revive growth. A 25 basis points CRR cut on May 3, to improve bank liquidity, and an Open Market Operation (OMO) of Rs 1.6 trillion is expected in FY14.

BofA-ML expects the RBI to cut rates by 25 basis points in its mid-June policy. "It will likely pause in H2-2013, with inflation set to climb to 7.5% from 6.5-7% in H1-2013 on hikes in diesel prices and power tariffs," the bank said. The central bank is then expected to cut policy rates by 50 basis points again in the March 2014 quarter, as inflation subsides.

Food price inflation will be key to the RBI's ability to cut rates in the second half of 2013, the report said. "A lot will depend on the pace at which food price inflation softens, although, obviously, monetary policy cannot affect it. A bit of good news is that the prices of potatoes, onions and tomatoes have come off in early March," it added.

According to the bank, four factors are responsible for the 300 basis points deceleration in economic growth between FY10-11 and FY12-14. These are a global downturn (150 basis points), RBI tightening (75 basis points), investment slowdown (50 basis points) and poor rains (25 basis points).