Tuesday, May 19, 2009


Thank Goodness!

Political stability strengthens end-09 bottom out…
Markets should welcome the return of political stability Monday. The Congress-led UPA, after all, convincingly returned to office belying all fears of a hung assembly. Political stability strengthens our end-09 bottom out hypothesis, assuming the G-3 stabilize 2H09 as we expect.

We expect a politically more confident Delhi to allow PSU banks to pare deposit rates - as CPI inflation comes off here - to cut lending rates to support growth.

Besides, the Congress could fund an additional 0.5-1% of GDP fiscal stimulus (~1% of GDP so far) in the July budget by divesting PSU stock. This poses some upside risk to our FY10-11 growth estimates: we estimate Re1 of public spend generates Rs1.5 of GDP. Finally, this defuses the possibility of political risks eroding investor confidence.

… eye ministry for policy cues
We would scan the new ministry to be sworn in on Friday for policy cues. The Congress has already announced that it will retain defense, finance, foreign and home affairs. PM Manmohan Singh is apparently ‘persuading’ Rahul, Congress president Sonia Gandhi’s son, to join his cabinet to spearhead rural development.

Stable Delhi likely to soften rate expectations…
A 25bp RBI rate cut (by July) to oblige the new finance minister should support gilts: read Ashish and me here. Second, gilts should also take comfort from the potential of divestment to moderate fiscal pressures. Third, PSU banks will likely follow the SBI into post-poll deposit rate cuts. Finally, this should culminate in a 50-100bp prime lending rate (PLR) cut by 1HFY10. Do read our rates roadmap here.

… and comfort fx flows
Fx inflows should improve with the political risks over the INR dissolving. Besides FII interest, the DLF stake sell should fetch US$750mn. Anyways, capital inflows have been recently healthy here. This, in turn, supports our twin view of BoP risks overdone/constructive medium-term INR outlook. Do read Christy and me here.

RBI, like investors, positioning for end-09 U in inflation
We are not surprised that RBI Gov Subbarao again flagged the need to ‘think’ about “reversing” his easy money policy, with commodity prices bottoming out. Inflation – likely 0.7% this week – should likely U by September to rebound to ~5% by March 10 (Chart 1). On our part, we expect the RBI to pause with a final by-July rate cut. Reversal should begin by April 10, assuming bottom out end-09
(Chart 2). Even if yields harden, the ~600bp spread between bank PLR and 10y offers sufficient cushion for soft lending rates to persist till 2HFY11 (Chart 3).

To see full report: INDIA WEEK AHEAD