Even though structural problems in Indian economy remains, Morgan Stanley feels that India is stabilising on account of lower current account deficit and inflows via NRI deposits. But it remains cautious on the country’s recovery

Morgan Stanley Asia Pacific (Morgan Stanley), in their latest note titled ‘Near-Term Relief, but Not Out of the Woods’, is cautious about the recovery of the Indian economy. They expect the balance of payments (BoP) deficits to be contained at $1.3 billion, with lower current account deficit (CAD). The note said, “We estimate a FY2014 BoP deficit of $1.3 billion in our base case, driven by a lower current account deficit of $59 billion, additional $15 billion inflows via deposits from non-resident Indians (NRIs) and relatively contained foreign institutional investment (FII) outflows.”
 

Morgan Stanley believes interest rates ought to be high for the economy to stabilise without going overboard. The report said, “While the balance of payment is important for the near term, the key to a sustainable external funding position for corporate and sovereign India is higher domestic real rates.”However, they feel that structural issues still remain most notably interest rates and asset quality of banks. The note said, “The key to stabilising macro remains higher domestic real rates, but unfortunately, that also de- stabilises Indian micro and for credit that means weaker financial sector asset quality and corporate funding risk.” Recently, Raghuram Rajan increased repo rates to reign in inflation. Morgan Stanley expects downward bias on inflation.


One of the key concerns of Morgan Stanley is the quality of assets held by the banking sector which is rapidly deteriorating. “The likelihood of a sustainable move depends on the stabilisation in bank asset quality and in corporate balance sheet quality,” said the note. Below is the chart that highlights the perils of the Indian banking system and Morgan Stanley expects it to get worse. This could stymie economic recovery.


However, India still remains exposed to external contingencies, especially on currency movements and economic recovery of the United States, and whether tapering will continue. Thus, one way to insulate this is to address domestic issues, though it remains to be seen if the Indian government will ever get around to doing this. The note says, “We expect India to remain exposed specifically to the trend in US real rates/US dollar and more generally to the external funding environment. Hence, we believe that the key will be to lift real GDP with policy reforms and change the expectation of the returns on investment for entrepreneurs by systematically addressing the issues related to the business environment.”
 

Regarding the Indian rupee, Morgan Stanley is bullish on the US dollar and Indian rupee and expects the domestic currency to touch 58 to the dollar from current levels.