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Four reasons not to ‘throw in the towel’ for India

Monday, 12 Aug 2013 | 11:17 PM ET
Dhiraj Singh | Bloomberg | Getty Images

The rapid depreciation in the Indian rupee, sluggish economic activity and deterioration in consumer confidence have dashed hopes for a turnaround in Asia's third largest economy. However, according to Credit Suisse, it's not all gloom and doom for the South Asian giant.

"We have not thrown in the towel. In some ways, the current situation reminds us of when virtually everyone had given up hope of ever seeing wholesale price inflation fall and the central bank cutting policy rates further. Sometimes patience is indeed a virtue," Robert Prior-Wandesforde, director, Asia Economics at Credit Suisse wrote in a new report.

(Read more: India holds rates to support rupee, gives dovish outlook)

Inflationary pressures have been easing this year, with the Wholesale Price Index (WPI), the country's main inflation gauge, rising just 4.86 percent in June compared with the near 8 percent levels seen in 2012. This has enabled the Reserve Bank of India (RBI) to cut interest rates three times this year.

Credit Suisse which forecasts gross domestic product (GDP) growth of 6 percent for the current fiscal year ended March 2014, on the higher side of market expectations, said its optimism lies in four main factors.

(Read more: Why market watchers aren't giving up on India)

Stemming the Indian rupee's decline
Khoon Goh, senior FX strategist at ANZ Research, says the new governor at the Reserve Bank of India can improve market sentiment toward the Indian rupee. Nicholas Ferres of Eastspring Investments joins the discussion.

Prior-Wandesforde argues that as long as the RBI's recent moves to tighten liquidity through increasing short-term borrowing costs for banks – in order to make it more expensive for investors to short the rupee – is not a precursor to a hike in the benchmark interest rate, the damage from tighter liquidity conditions is likely to be limited.

"This is our central view but does depend on the policy authorities acting in a quick and credible fashion to shore up the currency," he said. The rupee has fallen 11.3 percent against the U.S. dollar this year.

"Judging from the central bank's post meeting statement and press conference on 30 July, it has no intention of following up its liquidity tightening measures with a policy rate move. Rather it gave the strong impression that it actually was itching to undo the steps it had already taken in order to re-focus on boosting economic activity," he said.

(Read more: India's rupee hits record lows, here's what it means)

Secondly, he said that growth is unlikely to be as stunted as it was in the second half of financial year ending March 2013, when fiscal policy was being tightened to curb the government's deficit.

In addition, the county's exports are set to benefit from a weaker rupee and global demand picking up, he said. India's exports improved significantly in July, rising 11.6 percent year on year.

Lastly, this year's favorable monsoon rainfall is positive for the county's key agriculture sector, boding well for crop production and possibly food inflation, Prior-Wandesforde said. The monsoon is critical for 55 percent of Indian farmland that does not have irrigation.

(Read more: Is India's rupee back in the danger zone?)

"Overall, we believe the fundamentals are clearly more supportive of activity in 2013/14 than they were in 2012/13, suggesting economic growth should also be meaningfully stronger," he said.

Prior-Wandesforde acknowledges that there are risks to his outlook, in particular one: "the damage to India's normally strong 'animal spirits' from the numerous corruption and governance scandals."

By CNBC's Ansuya Harjani; Follow her on Twitter @Ansuya_H

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