Economic recovery to accelerate, says Morgan Stanley

Raghuram Rajan in his last monetary policy review left interest rates unchanged citing "upside risks"

The country's economic recovery is expected to accelerate in the long-term because of a rise in purchasing power, consumption growth and monetary policy easing, while inflation would remain below 5 per cent over the next two years, says a Morgan Stanley report.

"We believe this will be a longer duration expansion cycle with GDP (gross domestic product) growth expected to accelerate and inflation expected to remain at or below 5 per cent over the next two years," Morgan Stanley said in a research note.

According to the global financial services major, the recovery in the Indian economy will be fuelled by domestic demand, with factors like consumption, public capex and foreign investment playing a key part.

Five factors that will drive consumption growth sustainably include sustained moderation in inflation and improvement in purchasing power; trailing monetary policy easing and expectation of more easing; pay commission-related wage hikes for government employees; pick-up in job growth; potential improvement in the rural sector if the weather becomes supportive.

The macro environment has seen steady improvement in the last two years. However, the pace of growth recovery has been slower than anticipated, the report says.

Morgan Stanley expects inflation to be sustainably lower at 4.5 per cent year-on-year in the quarter ended March 2017, as drivers of both food and non-food inflation are likely to remain supportive of a deceleration in inflation.

Though the Reserve Bank of India (RBI) has highlighted that risks to inflation trajectory could emanate from food prices, impact of 7th Pay Commission and a possible impact from the goods and services tax (GST) Bill, Morgan Stanley believes that risks from these remain manageable.

"We continue to believe that CPI (consumer price index) inflation will remain on the path of moderation, reaching 4.5 per cent year-on-year by March. In our view, all the drivers of inflation (commodity prices, wage costs, fiscal consolidation, property prices) will remain benign, leading to a sustained deceleration in inflation trajectory," the report said.

On RBI's policy stance, the report said, "Based on our inflation forecast and the RBI's stated real rates target of 1.5-2 per cent, we expect another 50 bps of rate cuts in this fiscal year. We see a high probability of RBI reducing rates in the October meeting (full impact of monsoon season will be known)."

RBI Governor Raghuram Rajan in his last monetary policy review on August 9 left interest rates unchanged citing "upside risks" to inflation but said the central bank's stance remains "accommodative".

Expecting "upside" risk to his March inflation target of 5 per cent due to pay hike of central government employees following the 7th Pay Commission and sticky core inflation, which excludes food and fuel, he kept benchmark repurchase rate at five-year low of 6.50 per cent.