Improved prospects for a reduction in interest rates and efforts by New Delhi to calm foreign investors about tax concerns have enabled Indian shares to rebound, and the feel-good factor should underpin the market in the coming week.

With inflation remaining within limits of the central bank, many economists now expect the Reserve Bank of India (RBI) to lower rates when it reviews policy on June 2. If done it would be the third cut in borrowing costs since January 15, and a clearer indication the focus has shifted to supporting sluggish growth.

“India’s real interest rate remains higher than comparable peers at this stage, leaving room for RBI to cut rates further. Based on our inflation projection, we expect the RBI to cut the policy repo rate by 25 basis points each in June and August, which would still help to keep the policy real interest rate around 1.5 per cent in 2015-16,” economists Taimur Baig and Kaushik Das at Deutsche Bank said in a report.

Consumer price inflation in April stood at 4.9 per cent, while wholesale prices contracted 2.7 per cent. Even though fuel costs have risen in May due to higher global oil prices, most world commodities are still subdued and should keep inflationary pressure under control. Food prices, a crucial factor for the subcontinent given the large number of poor, are vulnerable to weather conditions and the government is expected to bridge any shortfall in output through increased imports or supplies from state warehouses.

The repo rate, which has been lowered by a total of 50 basis points in 2015, now stands at 7.50 per cent. Commercial banks, however, have been loathe to reduce their lending rates in equal measure citing mismatch of costs and profitability worries.

RBI holds key

“If the RBI does not cut rates now, there is a risk of the central bank falling behind the curve, given the considerable lag with which monetary transmission tends to impact the real economy,” the Deutsche Bank economists wrote.

Finance Minister Arun Jaitley has also thrown his weight behind calls for lower borrowing costs, but the final decision rests with RBI Governor Raghuram Rajan. In April, the central bank chief kept rates on hold after the RBI’s advisory monetary policy committee voted four-to-three for a cut, according to minutes released by RBI.

“We see a more than even chance of RBI cutting policy rates by 25 basis points,” economists led by Chetan Ahya at Morgan Stanley said in a report, referring to the June meeting. DSP Merrill Lynch too expects a quarter point reduction in the repo rate.

The possibility of the US Federal Reserve raising interest rates only by September, instead of June, should also encourage the RBI to loosen policy now.

“Market participants we met with widely expect a rate cut on June 2. They expect a total of 50-75 basis points of rate cuts by March, 2016,” Goldman Sachs said.

Good tidings

The top-30 Sensex rallied 2.3 per cent in the week to Friday, closing at 27,957.50 after rising as high as 28,071.16. It was the best performance since early April, thanks in part to a revival in foreign buying and strong support of domestic investors. The broader 50-share Nifty gained 2.4 per cent to 8,458.95.

A sharp correction in share prices — the Sensex had fallen from a record peak of 30,024.74 in early March — has made some stocks attractive. New Delhi’s belated efforts to halt a tax-notice drive against foreign funds demanding taxes on profits made many years ago also helped douse market jitters.

Foreign institutional investors (FIIs) were net buyers of shares worth $324 million (Dh1.2 billion) over three days, according to Credit Suisse, but net foreign buying has come off from 1.4 per cent of market cap last August to 0.8 per cent. Nevertheless, even after discounting for lower-than-expected earnings growth for companies, the outlook for stocks still remain upbeat albeit at a slightly lower trajectory.

Overseas investors poured nearly $6 billion into Indian markets in January-March, the 10th consecutive quarter of positive inflows, DSP Merrill Lynch said, adding that despite some outflows the position was positive so far in the June quarter.

“Strong inflows from the FIIs over the last five years have resulted in an all-time high foreign ownership for Indian markets at 24 per cent of the overall market cap of India,” the brokerage said in a report.

Keep faith

Citigroup lowered its end-December forecast for the Sensex to 32,200 from earlier projection of 33,000, and introduced a new target of 35,000 by June 2016, saying that investors must keep faith for stronger returns over the longer term.

While profit growth is set to slow down, the quality of earnings should improve as inflation cools and allows for lower interest rates. In the longer run, this would help consumer spending, boost earnings and accelerate investments.

“We see risks to nominal corporate growth as they adjust to a materially lower boost from inflation. We believe this argument would extend to broader industry growth measures where lower inflation is likely to moderate growth,” Citi analysts Aditya Narain and Jitender Tokas said in a report.

“We believe this transition could be a little unsettling for the market, as nominal ROE’s, earnings and growth measures, moderate in nominal terms. We believe 2015-16 could well be the year of this change — and while flagged, it’s a transition the market might not be fully prepared for.”

The analysts said that while there have been some hold-ups in government expectations, it was also essential to note some aggressive delivery such as the coal auctions and rated the government “fairly favourably”. Potential catalysts ahead were rate cuts, visible investment and policy announcements.

The investment bank said it was overweight on banks, cement, autos and pharmaceuticals and raised telecoms.

Citi’s top picks among large cap companies were: Adani Ports, Aurobindo Pharma, Axis Bank, Bharti Infratel, Coal India, Dr Reddy’s, HCL Tech, HDFC Bank, Mahindra & Mahindra and State Bank of India.

Among mid-caps, it preferred Apollo Hospitals, Bharat Forge, Container Corp, Emami, Exide, Info Edge, JSW Energy, Petronet LNG, Titan and Yes Bank.

The writer is a journalist based in India.