Boston, MA -- (SBWIRE) -- 06/12/2013 -- While the situation remains fluid, the Dravida Munnetra Kazhagam (DMK)'s decision to pull out of the ruling United Progress Alliance (UPA) coalition government at the centre significantly hampers the government's policymaking capacity.

It is becoming increasingly clear that the Indian economy is entering the early stages of a cyclical growth bounce. Having said that, the massive amount of uncertainty fomented by the country's dogged structural twin deficits suggests to us that any cyclical bounce is likely to be capped. As such, our FY2013/14 (April-March) and FY2014/15 real GDP growth forecasts stand at 5.5% and 6.0% respectively.

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The enduring size of India's current account deficit in the face of an ongoing growth deceleration is disconcerting, as it signals that the country has yet to undergo the external rebalancing needed to put the economy back onto an even keel. While the Indian rupee remains historically cheap at current levels, the reliance on portfolio inflows will leave the currency susceptible to the ebbs and flows of global risk sentiment.

We believe that gradual monetary policy easing by the Reserve Bank of India (RBI) will remain in play over the course of FY2013/14, as the central bank looks to lend its hand to reignite investment activity in the struggling Indian economy.

The budget plans for the current fiscal year were distinctly underwhelming, reflecting our earlier expectation for a mixture of both populism and pragmatism.

Major Forecast Changes

We have downgraded our FY2013/14 and FY2014/15 real GDP growth forecasts to 5.5% and 6.0%, from 6.2% and 6.7% respectively.

We now see the RBI's benchmark repo rate ending the current fiscal year at 7.25%, as opposed to 7.50% previously.

Given the country's still-sizeable current account deficit and the absence of any meaningful external rebalancing, we have adopted a neutral stance towards the Indian rupee.

Key Risks To Outlook

Downside Risks To Growth: The manner in which the government responds to looming electoral pressures in the run-up to the 2014 general elections could see the Indian economy swing either way.

In the bearish case, the government could opt for a more populist approach, which then leads to a further exacerbation of the country's twin deficits.

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