Despite current skepticism, India's growth should recover cyclically
Growth is already in the initial stages of a business cycle recovery. We expect GDP growth to rise to 7.8 per cent year-on-year in 2016 from 7.3 per cent in 2015, aided by private consumption (higher real disposable incomes), government consumption (pay hikes) and a slight pickup in investments (de-bottlenecking, public capex). We estimate India’s potential growth at around 8 per cent, which implies that the output gap will gradually narrow over the course of 2016, before closing fully by the first quarter of 2017. The implementation of the seventh pay commission award would mean higher inflation (transitory) and fiscal risks. We expect the quantity and quality of fiscal consolidation to suffer. We expect a slight slippage in the fiscal deficit to 3.6 per cent of GDP in FY17 (target: 3.5%) and a smaller rise in government-funded capex (increasing pressure on off-balance-sheet funding). As the disinflationary forces stabilise (oil, rural wages, negative output gap, MSP), we expect underlying ‘core’ CPI inflation to remain above the RBI’s 5% target in March 2017 (Nomura: 6.2%). Headline CPI inflation should rise above 6% due to higher housing allowances. With inflation expectations still elevated, we expect the RBI to keep policy rates on hold in 2016 and instead focus on greater transmission (small savings deregulation and marginal cost of funding). With higher domestic growth and real effective exchange rate appreciation, we expect a marginal current account deficit widening to 1.3% of GDP in 2016 from 0.9% in 2015. However, we expect the balance of payment surplus to continue. Key reforms: GST (possible implementation in Q3 2016), strategic sales, bankruptcy code, setting up of the monetary policy committee, IDBI privatisation, market-linked small savings rate, corporate bond repo, lower corporate tax rate and phasing out of some exemptions. Other triggers include state elections (Kerala, West Bengal and Tamil Nadu) by April/May; RBI governor’s three-year term comes to an end in September; redemption of USD25bn of FCNR(B) deposits in Q4. How we are different. (1) Despite current skepticism, we expect growth to recover cyclically; (2) We expect the RBI to stay on hold in 2016 as inflation surprises on the upside; and (3) We expect the fiscal deficit to slip to 3.6% of GDP in FY17. Nomura’s strategy view: Equity - Dec 2015 Sensex target of 33500 (under review). O/W sectors: financials, autos, industrials and technology. U/W: Consumer staples, pharmaceuticals, metals and telecoms. FX - USD/INR to depreciate from 66.7 in end-2015 to 67.4 in end-2016. Rates - 10yr bond yields to ease marginally from 7.6% by end-2015 to 7.5% by end-2016.