India - GDP to grow 5.7 pct in 09/10 - Morgan Stanley

MUMBAI (Reuters) - Morgan Stanley said on Monday it had cut its forecast for India's economic growth in the fiscal year starting April to 5.7 percent from 6.5 percent due to high cost of capital, falling consumer loan growth and reduced demand.

Morgan Stanley expects agriculture and allied sectors, which contribute around 20 percent to GDP, to expand 3.1 percent in fiscal 2009/10. Industry, accounting for a quarter of GDP, will grow 4.4 percent, while services are forecast to rise by 7.2 percent.

It forecast a 7.0 percent expansion in the year to March 31, 2009, below the central bank's forecast of 7.5-8.0 percent.

"Tight lending standards are likely to restrict consumer loan growth and private consumption spending. In addition, weaker global growth will also reflect in the form of a slowdown in external demand," Morgan Stanley economists said in a client note.

Asia's third-largest economy grew an annual average of 8.8 percent in the past five years and Morgan Stanley said the economy accelerated much faster than the potential growth rate in the period due to large capital inflows.

But in the past few months India has seen net capital outflows coinciding with tight liquidity conditions in the domestic banking system that led to a "disruptive spike in the cost of capital".

"Our approximate estimates based on FX reserves trend indicate that over the last five months, India has actually seen net capital outflows of $5-10 billion," it said.

The rupee has weakened sharply since August, and so far in 2008 it has depreciated nearly 17 percent. To temper the pace of its fall, the central bank has been selling dollars, squeezing domestic liquidity and pushing up borrowing costs.

The rupee hit an all-time low of 50.29 per dollar last month but closed at 47.35/37 on Monday.

The central bank has aggressively cut interest rates and banks' cash and bond reserve requirements in recent weeks to ease tight cash conditions and boost growth.

The main short-term lending rate has been cut by 150 basis points to 7.5 percent in 2008 and the cash reserve ratio, the proportion of deposits that banks must keep with the central bank, is now down 350 basis points at 5.5 percent.

Even so, Morgan Stanley said, higher lending standards and pressure on the rupee due to a widening balance of payment would keep interest rates high.

"We do not expect the banking system to cut the effective borrowing costs for consumers and corporate sector until the credit demand decelerates sharply and/or capital inflows revive meaningfully," the report said.