Two factors — interest rates and speculation on the annual budget — will be the guiding light for investors in Indian shares in February. With growth seen slower than expected there will be greater pressure on New Delhi to loosen the purse strings on spending as well as redouble efforts to push reforms needed to improve the business climate.

While the consensus among economists is for the Reserve Bank of India (RBI) to keep interest rates unchanged at its monetary policy meeting on Tuesday, there are some who believe that the central bank may lower the repo rate by a quarter point in line with the global trend to support the waffling manufacturing sector.

The Bank of Japan’s surprise decision on Friday to cut rates to below zero was the catalyst to lift equities across Asia, including in India. The rally helped the top-30 Sensex post its first weekly gain in four, up 1.8 per cent, while the broader 50-share Nifty gained 1.9 per cent. Both the indices, however, ended with a monthly loss of 4.8 per cent, their worst performance since last August.

Earlier China lowered borrowing costs and the European Central Bank has been pursuing a loose monetary policy to breathe life into their struggling economies. The US Federal Reserve, which raised rates in December for the first time in a decade, has hinted that it is unlikely to tighten policy anytime soon.

Bank of America-Merrill Lynch believes there is a “compelling reason” for the RBI, which slashed its repo rate by 125 basis points (bps) over four moves in 2015 to 6.75 per cent, for another reduction with inflation expected to stay within the central bank’s comfort zone and growth slowing.

“We continue to expect a final 25 bps RBI repo rate cut on February 2. That said, RBI is approaching the end of its rate-cutting cycle,” the US investment bank said in a research note.

Barclays economist S. Sanyal has called for a more than 25 bps cut in the repo rate in 2016, citing “moderate inflation and only a gradual uptick in economic activity”.

On Friday, New Delhi revised down its annual economic growth for the financial year that ended in March 2015 to 7.2 per cent from 7.3 per cent reported earlier as well as for the year before to 6.6 per cent from 6.9 per cent. Economic expansion in 2015-16 is expected at 7-7.5 per cent, down from 8.1-8.5 per cent seen earlier.

Tough call

RBI Governor Raghuram Rajan is unlikely to heed calls for loosening and is likely to follow status quo until the central budget is unveiled by the end of February. He is expected to make dovish noises but remain steadfast to his belief that India must tidy up its fiscal position rather than unleash easy cash into the system.

In a blunt speech on Friday, Rajan pooh-poohed talk among policymakers that it would be OK to stretch fiscal deficit or dilute consumer price inflation target so long as the money is pumped into infrastructure projects that can spur more jobs and bolster economic activity.

“If every time there is any minor difficulty, we change the goalposts, we signal to the markets that we have no staying power. Let me therefore reiterate that we have absolutely no intent of departing from the inflation framework,” he said.

Rajan, a former IMF chief economist, warned that India should avoid the pitfall that has unravelled Brazil, which passed big stimulus measures and slashed interest rates but is now suffering from the hangover of those policies.

In other words, when the global economy is struggling it is better to temper expectations.

“It is at such times that we should not be overambitious,” Rajan said. “We should be very careful about jeopardising our single most important strength during this period of global turmoil — macroeconomic stability.”

Braving it out

The big event coming up is the annual budget, delivered on the last day of February, and Prime Minister Narendra Modi will have to work harder to get his reform bills off the board and help steer the country to a faster growth trajectory, essential to create the jobs for millions of youth pouring out of universities every year.

The government has plugged loopholes in subsidy schemes through better delivery to the deserving, streamlined public auction process for natural resources, eased the rules for doing business in many sectors, jump-started stalled projects and aggressively pursued “Make in India” campaign to make the country a manufacturing hub.

It has also stepped up spending on large road and rail projects, vital for accelerating growth in the wider economy as well as fix a festering problem with debt-laded state electricity boards that stymied large power projects.

The policies have triggered greater foreign direct investment but the pace has been slow because of cumbersome procedures that still hobble investors. “The frictional cost of doing business here is intimidating at times,” John Rice, vice-chairman of GE, told the ET Global Business Summit in New Delhi on Friday. “Taxes, paperwork, permits can be improved.”

Political wrangling and dysfunctional parliament have been the bane for New Delhi to get many of its reform policies off the ground. Bills that have been held up for months include a Goods and Services Tax (GST), land and labour reforms, a bankruptcy act and opening up to foreign investment — all deemed essential to speed up growth.

“The positive news is that these reforms are occurring and are going in the right direction even if the speed of these reforms may not be as fast as one would want,” said Nouriel Roubini, head of US-based Roubini Global Economics, an independent macroeconomic research house.

Pick your stocks

For stock investors, the best opportunities would be to go long on consumption plays and government policy beneficiaries, according to Ridham Desai, head of India research at Morgan Stanley.

“We have seen strong improvement in roads sector and expect more from the railways in the coming months,” he said in a report. Among his top picks were L&T, IRB Infrastructure, UltraTech Cement, Power Grid and Tata Motors.

Desai expects the GST bill will be passed in the coming months and implemented by early 2017. The big gainers from the tax reform include Havells India, Jubilant FoodWorks and M&M. Improving urban and rural consumption should also help these companies.

Among software services exporters, his top picks include Infosys and HCL Technologies. The dollar is likely to appreciate against the rupee through 2016, providing a boost to the earnings of exporters. A stabilising US economy is also good news for the sector.

Desai also expects more interest rate cuts and sees private-sector banks with strong retail loan growth outperforming their state-run rivals or public sector undertakings (PSUs).

“Our favourites include HDFC Bank, IndusInd Bank, SKS Microfinance and Axis Bank. The only PSU is Bank of Baroda, where the recent management change may drive performance albeit from a medium-term perspective of 3-5 years,” he added.

The writer is a journalist based in India.