High fiscal expenditure may push up interest rates in 2013

Fundamentally, Indian economic performance tends to be determined by three broad trends. These include the landed cost of crude oil; the aggregate agricultural output and the annual fiscal deficit. The interplay of these three broad factors determines the nature of inflation and interest rates in the economy. This, in turn, impacts aggregate demand and supply in the economy. Debt and equity markets remain a function of these wheels.

Our expectation is that the international crude oil prices might average around $110 per barrel for most of the calendar year 2013 (provided no external shocks occur). We also believe that the volatility in the rupee may have bottomed out and a range-bound movement or mild appreciation may be in the offing for most of 2013.

Consequently, in the absence of any supply shock, the economy can expect the fuel-led inflation to moderate on account of the high base in 2012. However, the structural demand pull in the economy may not allow the WPI-based inflation to go below 6% in the near to medium term.

Yet, this may provide the RBI the necessary window in the early half of 2013 to reduce the repo rate by at least 50 bps. This change may provide an investment and consumption stimulus to the industrial sector, thus revving up the growth engines of the economy. GDP growth in 2013 is expected to be in the 6.8-7% territory.

The debt market is increasingly basing its outlook around the above viewpoint. The market may react positively to a rate cut, with possible yield compression across the rate curve and the credit-rating band. Liquidity in the market, however, may continue to remain in the negative.

With equities market trading at around the long-term valuation average , the possibility of improved market performance, based on better economic outlook, is there. India continues to remain one of the few major markets that provide growth opportunities. With limited global investment opportunities, FII and FDI participation increase.

A caveat to this scenario may be the high fiscal expenditure on account of early general elections. This might push up the real interest rates in the economy and further delay the much-needed recovery. However, the current initiatives on investment reforms and steps on subsidy rationalisation provide hope that government may be able to balance its political and economic responsibilities.

SANDESH KIRKIRE
CEO, Kotak Mutual Fund

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