India's Economy: Positives And Concerns

Includes: IBN, INDA, INXX
by: Disruptive Investor

The Indian central bank has cut interest rates by 25 basis points today, and this will help the economy gain further traction.

The monsoon is the key concern for India in the foreseeable future, and a good season can translate into further rate cuts and strong GDP growth.

The current correction in Indian markets is a good long-term buying opportunity, and investors can consider exposure to the index and to the banking and infrastructure sectors.

I have been positive on the Indian economy and equity markets after the new government assumed power in May 2014. While the pace of reforms has been slower than expected, they are in the right direction, and I maintain my optimistic stance on the economy and the equity markets. The trigger for writing this article is a 25 basis point cut in interest rate by the Indian central bank on Tuesday and its implications on the real economy. The article discusses the key positive and concerns related to the country's growth in the coming quarters.

I share Dr. Marc Faber's view that India's central bank is probably the best central bank in the world. It has minimal influence from the government in its operations, and the bank has played a major role in stabilizing the Indian currency over the last one year. As the chart below shows, the Indian rupee has been the second-best performing currency in 2014 against the dollar.

In my view, the 25 basis point interest rate cut has come at the right time and should help accelerate India's growth in the coming quarters. It appears that the markets were expecting a 50 basis point rate cut, and the disappointment is clear, with the markets falling by 2% after the announcement. However, I contend that the RBI has made the right decision, considering the following points:

  • Retail inflation in India has been on a decline in the recent past due to lower oil prices, and this gave the Indian central bank the required buffer to cut interest rates.
  • However, there is uncertainty related to the monsoon, and a bad monsoon can translate into higher prices for food, which forms a major portion of the spending basket.

    While food inflation due to a bad monsoon is not related to rate cuts in any way, a healthy economy would always have interest rates higher than the rate of inflation. Therefore, the Indian central bank has taken a cautious stance, and I believe that there will be further rate cuts if the monsoon is close to normal.

According to the RBI:

First, some forecasters, notably the IMD, predict a below-normal southwest monsoon. Astute food management is needed to mitigate possible inflationary effects. Second, crude prices have been firming amidst considerable volatility, and geo-political risks are ever present. Third, volatility in the external environment could impact inflation. Therefore, a conservative strategy would be to wait, especially for more certainty on both the monsoon outturn as well as the effects of government responses if it turns out to be weak.

Therefore, relatively higher oil prices in the last few months are also a concern, and I do think that it's important to discount the geopolitical factors, which is what the RBI has done. Clearly, the approach is more cautious than aggressive, and if inflation remains under control, growth will be robust. I must add here that a deep rate cut would also have impacted the currency, and currency depreciation is another source of inflation.

Therefore, the RBI's stance is positive overall, and I hold that the rate cut will have a favorable impact on economic growth once the banks lower their lending rates. In particular, the rate cut will help the "Make in India" campaign gain traction, along with carrying benefits for the capital-intensive infrastructure sector.

From a forward-looking perspective, the third bi-monthly monetary policy statement will be announced on August 4, 2015, and the outcome of that meeting will largely depend on how the monsoon pans out in India. If the rainfall is good, I expect another rate cut in August 2015.

I also believe that it's a good time to accumulate Indian equities with a long time horizon. The country's economy has a long way to go if policies are right, and the current government is moving in the right direction. Among individual stocks, I have recommended ICICI Bank (NYSE:IBN) in the past, and I continue to remain bullish on it. The bank will be a key beneficiary of higher consumption spending in India, which has the best demographics in the world. With the recent rate cuts and low inflation, I expect consumer-driven credit growth in the coming quarters. In addition, the iShares MSCI India Index ETF (BATS:INDA) and the EGShares India Infrastructure ETF (NYSEARCA:INXX) look interesting for investment from a long-term perspective.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.