Growth prospects of the Indian economy could take a fresh hit from the recent move by the Reserve Bank of India (RBI) to pull out liquidity from the money markets.
Indranil Sen Gupta, India economist at Bank of America Merrill Lynch, on Tuesday cut his growth forecast for the current fiscal to 5.5% from 5.8% earlier, saying RBI’s tightening will push back lending rate cuts.
“We had earlier expected growth to stage a shallow recovery to 5.8% on the back of better rains and lending rate cuts. We have now removed the 30basis points we had expected from softer rates,” he wrote.
The RBI on Monday put limits on banks borrowing under its overnight borrowing facility and also hiked rates on borrowing under exceptional window, also known as marginal standing facility (MSF) by 200 basis points. These measures could make funds for lending scarcer or even more expensive for Corporate India, in turn hurting GDP growth.
Sonal Varma, economist at Nomura, too believes that there is a risk that RBI’s measures could backfire.
“India’s growth is already very weak and tighter domestic liquidity will worsen the financial conditions for corporates and banks, hurting asset quality and the growth outlook,” said Varma.
Varma believes there is a downside risk to their GDP growth estimate of 5.6% for fiscal 2014.
The central bank has been on an easing cycle to boost India’s slowing economy. It has also cut cash reserve ratio and conducted bond purchases to infuse more liquidity into the market with the hope that more money finds its way to the borrowers. However, Monday’s announcement could turn the table around.
Tushar Poddar, economist at Goldman Sachs India, too, sees the current measures posing downside risks to its recently revised GDP growth expectations of 5.4% for 2013.
With growth expectations declining, the experts see risk to upside in equity markets as well.
Morgan Stanley has lowered its Sensex year-end target by 9% from 23069 to 21084 as it believes that RBI’s move to defend the currency overnight by quantitative tightening (reducing rupee supply) may take its toll on the equity and bond markets.
“This increases the downside risks to growth, raises cost of money and dampens domestic liquidity. From an equity market perspective, we think this puts a cap on the markets in coming weeks. However, the biggest damage in recent weeks has been on the liquidity construct – both global and domestic liquidity appear less favourable,” wrote Ridham Desai, Sheela Rathi and Utkarsh Khandelwal, analysts at Morgan Stanley in a report on Tuesday.
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