Macro and Equity Market Outlook

Indian equity markets (Nifty) have corrected 11.4% from their October 2021 peak and 4.6% on CYTD basis. Stubborn inflation, concerns of rising rates/tight monetary policy on economic growth and geo-political tensions amid Russia Ukraine war has resulted in sharp drawdown in global equity markets.

 Indian markets witnessed significant FII outflows since their peak. FII outflows are just short of breaching the FII outflow level (as a percentage of market cap) observed during the Global Financial Crisis.

On the contrary domestic flows continue to remain strong and counter balanced the significant FII selling pressure. FIIs have sold cumulative ~USD 27bn, while Domestic Institutions have purchased ~USD 29bn since 01 October 2021 till 31 May 2022.

Markets of late have found support and rebounded from their lows on initial signs of inflation peaking in the US. The US Fed minutes provided some comfort that didn’t show more aggressive path being mapped to tackle elevated inflation and is factored in estimates. Policymakers unanimously felt the US economy was very strong as they grappled with reining in inflation without triggering a recession.

Besides, US President Biden’s remarks about the prospect of reducing tariffs on China, which could represent a major de-escalation of the trade war and more importantly China’s expected easing of covid restrictive measures will likely resolve the supply side constraints to a certain extent. Brent crude prices remain in the $110-120 per barrel range as EU plans to ban Russian oil imports are being offset by higher crude supply from other OPEC+ countries.

 In India, attempts to contain inflation have commenced. The Government of India has announced a range of measures to curb inflation – a) Cut excise duties on petrol and diesel by Rs. 8 and Rs. 6 per litre respectively b) Imposed export duties on most steel products (15%) and on iron ore (to 50%) c) Reduced import duties on coal to 0% and on naphtha (from 2.5 to 1%). These measures announced by the government are a follow-up supply side measures to curb inflation after the out-of-turn repo rate and CRR hikes initiated by the RBI.

The primary impact of these measures on inflation is likely to be modest, however the secondary impact will be higher as consumers will benefit from lower costs, although the benefit will accrue with a lag.

These measures will have negative impact on steel companies’ earnings growth and positively impact consumer discretionary (auto) and consumer sectors. On the flip side it means loss of revenues for the government due to duty cut and higher food/fertiliser subsidy will mean higher borrowings to fund this deficit.

Market valuation is now close to its 10-year average multiples and certain stocks’ valuation looks more reasonable relative to its growth outlook. The key question is whether the market sell-off is now overdone and whether the recent rebound is sustainable. With the end of easy money, market risk tolerance is low. While the pressure on margins due to higher raw material expenses is well known and articulated as well, market has started punishing stocks that have missed earnings estimate or reported poor results and this seems unlikely to change in the near term. The 4QFY22 earnings season so far has been mixed and broadly in line with expectations. For FY23, Nifty earnings growth estimates have been downgraded to 13-15% and `likely risk of further downgrade remains as inflationary environment will likely drag demand lower.

Sentiments seem to have improved recently and global equities have staged a good comeback on the hopes of peak inflation in the US and post the resultant deep drawdown in the market, especially in the growth oriented “Tech and TAM” stocks. While the sentiment improvement is encouraging, there’s still a lot further to go in terms of series of rate hikes and liquidity tightening. It needs to be seen how long the optimism (relief rally) lasts amid the risk of recession fears and rising inflation levels across the globe. We expect the market to remain range bound in the near term, amid challenging macro. However, the medium to long term fundamentals of the Indian economy remains intact.

Fixed Income Market Update and Outlook

Economic Growth:

Indian economy grew at 8.7%y/y in FY22 (Previous estimate: 8.9%y/y, FY21: -ve 6.6%y/y) indicating resilience despite various waves of pandemic, war and supply issues. Growth was primarily driven by consumption, capex and robust exports from expenditure side and manufacturing, agriculture, construction and public administration from production side. While annual print looks robust, there has been loss of momentum in quarterly numbers. 4Q FY22 GDP growth moderated to 4.1%y/y (3Q FY22: 5.1%y/y). Omicron wave in January inflicted temporary loss in momentum in that month, thereafter war and supply issues proved to be headwinds.

Inflation:

Twin shock (Russia-Ukraine war and China lockdown) continued to impact monthly inflation print in India and across globe. After rising sharply in March, India’s Headline CPI print jump to record high level of 7.79%y/y in April (Mar 2022: 6.95%y/y, Feb 2022: 6.07%y/y and as against Apr 2021: 4.23%y/y). This was much higher than the consensus estimates of 7.4% y/y. Apr 2022 headline print was highest since May 2014. Rise in inflation was driven by food, fuel, clothing and services .

Like March, Sequential momentum in headline was much higher than the seasonality and was broad-based indicating direct and indirect pass-through of rising crude prices and global supply issues. Core inflation (excluding food, pan and fuel) rose sharply to 7.24%y/y (Mar 2022: 6.53%y/y and after remaining ~6.20% lvls between Oct 21-Feb 22).

Headline number is now almost 2% over the higher bound of RBI’s target range and expected to remain elevated in 1Q FY23 on global macros (elevated commodities, lingering supply chain issues) and domestic factors (rising cost of production, pick-up in demand). In May policy, RBI Governor has given clear indication that the inflation was key concern and bringing back policy rate to pre-covid levels was top priority, so rate normalization was way forward.

Monetary:

In surprise policy meeting in early May, RBI hiked the key policy rate by 40 bps to fight inflation on war footing. Further, in move to reduce humungous system liquidity and improve efficacy of the rate hike, RBI hiked the cash reserve ratio (CRR) by 50 bps. Further, Governor gave clear indication to remove the accommodation provided under pandemic at earliest – signalling 75 bps hike in upcoming meetings to bring policy rate back to 5.15% (pre-pandemic levels). Accordingly, in June’22 policy, RBI raised the key policy rate by 50 bps to 4.90%. This move was in line with path set out in May’22 policy and hence was along the consensus expectations. Expectations are now build-in for 25 bps hike in Aug’22 meeting. It also revised upward FY23 inflation projections by 100 bps to 6.7%.

As indicated in previous note, globally, most central banks have already embarked on the path of normalisation. Now with inflation risk lurking in backdrop of rising geo-political risks, monetary policy tightening is being followed by vigour. After starting normalisation process (25 bps hike) in March, US Fed hiked the policy rate aggressively by 50 bps, with plan to hike rate in subsequent meeting in 2022 and of similar size over next couple of meetings. It also announced a plan to start its QT programme from June. Bank of England continued with its rate normalisation process in May’22 (it has been hiking in every meeting since Dec 2021). There are early indicators that with sharp rise in inflation, ECB plans to start raising the rates as early as 3Q CY2022.

Debt Market View:

Normalization of Liquidity Adjustment Facility (LAF) corridor via hike in lower bound of LAF corridor (in Apr’22), surprise rate hike by RBI (in early May’22 policy) followed by 50 bps hike in Jun’22 meeting with hint for many more can be an indication of change pivot. Especially May’22 hike is clear indication of front-loaded and aggressive nature of policy. Now inflation has taken clear precedence over the growth and based on evolving inflation trajectory, upcoming policy meetings seems like live policy.

Persistently strong inflation has forced central banks globally to front-load and exercise larger hikes. RBI’s actions since Apr’22 are steps in same direction. Unlike baby steps (25 bps) option exercised during the pre-pandemic times, record high headline inflation print (along with broad-based and sticky nature) has compelled RBI to do more (>25 bps hike) and faster (Apr, May, June) since Apr’22 policy.

As expected, RBI revised upward FY23 inflation projection and maintained growth outlook. Despite rising headwinds for growth and tailwinds for inflation, projections seem more in line with consensus expectations and hence realistic. So, while there are lot of uncertainty to outlook, RBI’s future rate actions are likely to be calibrated and measured (unless there is shock).

In early May’22 meeting, the US Fed hiked the key policy rate by 50 bps (in line with market expectations). Further, it decided to kickstart QT (quantitative tightening) from June 1, 2022 (early start) Normalisation process (rates and liquidity) of US Fed has already started impacting yields and flows to emerging markets (including India). While the latest move was already anticipated by the market, the market will watch out of future rate & QT trajectory and sound bite from US Fed.

With crude inching up since May’22 start, there are growing concerns about economic growth and inflation (domestic and global). As a result, the Indian government has cut the fuel tax, increased subsidy substantially to give fiscal support to growth. While this will have fiscal implications, the move may

That said, the evolving geopolitical risk may continue to be determining factor for growth, inflation, fiscal, trade, currency, supply chain and financial market outlook.