‘Short-term risks rising in India’

HONG KONG: Concerns about a further overheating of the Indian economy persist, and a further rise in rates may be required to get inflation sustainably under control, says HSBC chief Asia economist Peter Morgan.

“We think the RBI is behind the curve on inflation, and that's why they've started to move aggressively,” Morgan told DNA Money in Hong Kong. “But it will take some time to get the inflation genie back in the bottle. We think GDP growth will have to slow down first, and that in turn will bring down the inflation rate.”

Does he think the 'India story' — which was the flavour of the season for much of recent years — was already wearing out? “Well, actually, we've been a little bit skeptical of the India growth story —in the sense that a lot of people have been arguing that trend growth has gone up to 8-10%, but we struggle to find evidence to support that," says Morgan. “There have been four years of very good growth, but if you look at capacity utilisations, they’ve all gone up dramatically. We think trend growth is still in the 6.5-7% range.”

“Average growth over the period 2003-04 to 2006-07 is likely to have been 8.4% — well above our estimate of the sustainable growth rate, which we put at 6.5-7%. We are also looking for an above trend 7.8% GDP rise in 2007-08.”

Noting that WPI inflation was running in excess of 6%, Morgan said money supply growth was above 20% and credit growth too was close to 30%. “At the same time, survey measures of capacity utilisation in industry suggest that 98.6% of firms are operating at or above an ‘optimal’ level.”

The combination of the government’s widespread reductions in import and fuel duties, the prospects of a good winter harvest and a more favourable base effect should drive WPI inflation towards the RBI's target.

“But this,” says Morgan, “is likely to prove a temporary drop".

“In the meantime, this year we expect a further 50 basis point rise in the repo and reverse repo rates, to 6.5% and 8% respectively, as well as a 100 basis point (or 1 percentage point) rise in the Credit Reserve Ratio,” Morgan said.

What does all this mean for the stock market? HSBC pan-Asian equity strategist Garry Evans is "underweight" on India.

“Although India is a little cheaper that it was it still looks a bit overvalued, and we do think there are still problems with the economy,” says Evans.

In his estimation, "fair PE" for India is 14.1, against 16.4 now, and a 2007 peak PE of 18.9.

“Short-term economic risks are increasing in India, adding to the pressure on earnings.”