Is the growth-inflation nexus similar to 2003-05?

Moneylife Digital Team 01 April 2015

The 2003-05 cycle also saw a pickup in growth along with low and stable inflation, similar to the current cycle and sustained deceleration in inflation would provide room for more monetary easing, feels Morgan Stanley

The current cycle of growth pickup and low and stable inflation appears similar to the one India witnessed during 2003 and 2005. While investors have raised concerns about the sustainability of inflation deceleration, Morgan Stanley says it expects growth momentum to pick up while there would not be a rise in inflationary pressures.

"We believe the inflation trend in the current cycle will be somewhat similar to that in 2003-05, considering the domestic and external macro environment. We are more constructive on the inflation outlook compared with consensus, and we expect inflation to decelerate to 4.75% by end-2015. While we expect growth momentum to pick up, we do not expect a rise in inflationary pressures," Morgan Stanley said in a research report.

Like in the current period, the economy was in the early stage of recovery in 2003-05. In the previous cycle, acceleration in growth was accompanied by significant improvement in productivity, which kept inflation low and stable.

The report says, "Looking at the previous cycle, we see that drivers of inflation currently are following a similar path as in that cycle, as well as having the added support from lower global commodity prices in the current period. Moreover, as we saw in the previous cycle, we believe that as growth picks up in the current cycle, the productivity-driven nature of the growth recovery will not lead to a rise in inflationary pressures. Moreover, with a high level of unemployment and continued high growth in working age population, we do not expect wage pressures from a rise in capex-led growth."

Analysing the drivers of inflation, Morgan Stanley says it believe that key factors which influence CPI inflation trend are, wage growth, fiscal policy, growth-mix, real interest rates and global commodity prices. "Comparing the drivers of inflation between the two cycles we see that domestic factors are moving along similar lines as in the 2003-05 cycle and decline in global commodity prices are an added support in the current cycle," it added.

According to Morgan Stanley, sustained deceleration in inflation would provide room for more monetary easing. However, from an underlying cost of capital perspective, it says it believe that deposit rates could decline by significantly more than policy rates.

"We forecast a sustainably lower inflation path of 5% to be achieved from April 2015, and we expect inflation to decelerate to 4.75% by December 2015. Based on our expectation of the inflation trajectory, we believe the Reserve Bank of India (RBI) could lower rates by a further 75-100bps in 2015," it added.

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