The stock broking arm of HSBC group also predicts rise in interest rates by 100 basis points in the current fiscal and increase in inflation rates.

It has also downgraded the banking sector from neutral to underweight as most banks are likely to be affected by the economic slowdown and higher interest rates, leading to rise in bad loans.

In its monthly update for October, it expects India's fiscal deficit to worsen to 7 per cent of GDP from its earlier forecast of 6.2 per cent. The government has projected fiscal deficit of 5.6 per cent in the current fiscal.

It expects a GDP growth of 3.6 per cent in the current fiscal from its earlier forecast of 3.8 per cent.

HSBC Securities said although India stands out on a relative scale, it continue to believe that on an absolute basis, the Indianfundamentals are worsening. No economic upturn could be expected over the next 18 months, it said.

Increased monetisation would lead to higher inflation and interest rates, the report said.

It expects the rupee to depreciate sharply to Rs 46 a dollar by the end of the current fiscal, and further by 20 per cent to nearly Rs 55 by March 2000.

On downgrading of the banking sector, HSBC Securities said lower economic growth rate would lead to poor credit offtake and lower demand for goods and services resulting in low interest income and deterioration in the asset quality of banks.

Highlighting the reason for deteriorating assets quality, it said slowdown in various cyclical sectors like steel, cement, textiles and chemicals would lead to default by borrowers.

It also feels that higher interest rates would on the one hand increase income on loans leading to rise in interest spreads and on the other would depreciate the value of securities, which seek greater provisioning. Besides this would affectinvestments in the economy resulting in lower growth in the medium term, the report said.

The government's bid to kickstart the economy through increased lending was leading to risk-prone exposures by the banks. Though the move has resulted in improving the credit offtake it was sending danger signals of a return to micro-management by the Reserve Bank of India.

Bad loans were likely to lead to no interest income and at times to writing off loans in full.