Lending rate cuts key to recovery: BofAML

Does not expect investment to turn around till lower lending rates revive demand

Reduction in lending rates is essential to revive the slowdown in India's economic growth, Bank of America Merrill Lynch said today.

Global downturn, high interest rates, muted investments and poor rains have led to deceleration in India's economic growth. The gross domestic product (GDP) is now expected to grow at its slowest pace since 2003-04. The GDP is estimated to grow at 5% in the current financial year.

"We continue to attribute the 300 basis points deceleration in growth between financial years 2010-11 and 2012-14 to four factors: a global downturn (150 basis points), the Reserve Bank of India's tightening (75 basis points), investment slowdown (50 basis points) and poor rains (25 basis points). On balance, India's slowdown is comparable with that seen across BRICs," Indranil Sen Gupta, India economist with Bank of America Merrill Lynch, wrote in his note to clients.

Sen Gupta said investments were affected mainly on account of high lending rates rather than falling productivity. "In fact, India is that rare economy in today's world in which lending rates are stuck at 2008 peak levels. This is why we have been expecting the Reserve Bank of India – correctly – to continue inject liquidity to bring down lending rates," he said.

Bank of America Merrill Lynch believes that more than economic reforms lending rate cuts are needed to encourage investments.

"Can reforms revive investment? Not until the summer 2014 polls and some stability in the G-3, although Delhi's reform initiatives have boosted sentiment...We do not expect investment to turn around till lower lending rates revive demand. Although much is made about how investment pushed up growth in the last up-cycle, it is sometimes forgotten that investment itself was boosted by the unprecedented lending rate cuts after the 1998 South Asian crisis in the first place," Sen Gupta said.