India's lending rate cuts key to cyclical recovery

India's June quarter GDP growth on 31 August is expected to remain weak at 6.8% yoy, down from 7.5% in the March quarter, as high real rates continue to delay recovery. However, March quarter growth was largely on account of bunching up of taxes at the end of the financial year that saw 18.9% growth in net taxes. The gross value added, i.e., GVA = GDP - net taxes, which is the true measure of economic activity, was only 6.1% in the March quarter. 

Adjusted for net taxes, a slow recovery expected in this quarter, as lending rate cuts typically take around six months to transmit to the real economy. A recovery in 2H rests on an additional 30-40bp cut in lending rates and some remission in ex-post real lending rates with core-WPI inflation expected to pick up to 3.5% by March 2016 as oil base effects reverse. 

"Our industrial recovery measure - the average of year-over-year IIP growth this month (ie, May 2015) and the corresponding month last year (ie, May 2014) is beginning to show some turnaround. We expect June IIP growth on 12 August to improve to 4.2% from 2.7% in May," says BofA Merrill Lynch.