India's brightness hinges on inflation

Mumbai: While India is now considered the brightest spot in the emerging market universe, rating agency Moody’s Investors Service on Wednesday said that a revival in corporate earnings growth, pick up in domestic consumption and inflation trend would determine the direction of the markets in 2016.

Moody’s Indian affiliate, ICRA Limited, anticipates a boost in consumption in 2016 from the pay revision for government employees and pensioners, as well as a potential upturn in agriculture and therefore rural demand. ICRA however,  believes that a broad-based pick-up in investment will only unfold with a lag.

“India enters 2016 on the cusp of a cyclical growth recovery, with inflation under control and the economy benefiting from lower commodity prices. However, we believe that these advantages will only yield sustainable growth acceleration once Indian corporates and bank balance sheets are repaired, and if the private sector remains internationally competitive,” said Atsi Sheth, associate managing director, Moody’s.

Indian authorities have faced difficulties implementing high profile policy changes such as the GST, the rating agency observed and added that the government has initiated a wide range of measures over the last year to spur infrastructure investment, permit greater foreign direct investment, implement inflation targeting, and address banking sector constraints.

Ms Sheth believes that inflation and corporate profit trends in 2016 will offer clues as to whether these policy efforts have successfully created conditions for growth that are sustainable over the next three to four years.

Moody’s believes that low inflation would indicate a greater balance between domestic demand and supply conditions, and would help India’s private sector remain internationally competitive. Since, corporate taxes are an important source of government revenues, Moody’s believes that stronger corporate profits will support the government’s fiscal consolidation efforts.

While the pay revision for government employees and pensioners will boost consumer demand, the agency believes it will also pose a challenge to fiscal and inflation management. According to it, a normal monsoon after two successive years of poor rainfall would boost agricultural output, restore the purchasing power of the farm sector, and generate an uptick in rural demand.

However, moderate capacity utilisation and the availability of cheaper imports will restrict the pace of overall capacity expansion. “The private investment will also continue to be constrained by the high leverage levels of various corporate groups, the weak asset quality of the banking system, and structural issues plaguing sectors such as steel and power generation,” the rating agency said.