Positive sentiment may help rural spending but it may not necessarily be backed by sharp improvement in rural incomes, the report says.
Forecast of above-normal monsoon this year has rekindled hopes of a rural recovery, but its role in doing so is not that "significant", says a UBS report, thus striking a contrarian tone to the mainstream idea.
According to the Swiss financial services firm, sentiment plays a role and can help rural spending "though not necessarily backed by a sharp improvement in rural incomes".
"Agri GDP comprises 15% of India's GDP and 40% of rural economy. Our analysis implies that around 20% of agri GDP is directly dependent on monsoons.
Thus, the direct role of monsoon overall appears insignificant," UBS said in a research note.
According to the global brokerage firm, markets may be already pricing in a good monsoon. Nevertheless, if monsoon forecast materialises, rural stocks can continue to do well as actual impact may be seen only later.
"Our Nifty target for end-2016 is 7,500 with an upside scenario of 8,400 - market is now trading near our upside scenario, making the risk-reward unattractive near-term," UBS said.
The brokerage remains "constructive" on India in the medium term (1-3 years), but noted that "at these levels we would advise caution against getting carried away".
The report further said impact of poor rainfall on food inflation is less obvious historically and monsoons directly impact 25% of CPI. "In our view, food inflation in India reflects more the political economy," it said.
After two back-to-back years of drought, it is imperative for India to receive a good monsoon this year. Most indicators thus far suggest a strong likelihood of above-normal monsoon.
Meanwhile, the government has stuck to its policy stance of lowering inflation rather than stimulating short-term growth, as reflected in its fiscal stance.
"It has preferred to look at longer-term solutions for rural economy (crop insurance, more irrigation, and fostering better market access) rather than giving near-term stimulus in the form of higher MSPs (minimum support prices) or sharply higher rural subsidies," the report said.
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