Vijay Kumar Gaba

(a)   Mother Nature helping a bountiful crop (especially vegetables);

(b)   Current rise in inflation being transitory in nature; but MPC is ready to preempt the second-round impact;

(c)   Capex (both public and private) sustaining despite positive real rates and diminishing liquidity and continuing to remain broad-based;

(d)   Growth in the Indian economy staying resilient enough to withstand the external challenges; and

(e)   Government taking adequate steps to mitigate supply-side shocks, while maintaining fiscal discipline, trade balance, and growth stimulus.

Evidently, RBI has no solid basis for making these assumptions.

The monsoon is not only deficient, it is poor both temporally and spatially. Only 42% of districts in the country have received a normal (-19% to +19% of normal rainfall) so far. The remaining districts are either deficient (-20% to -85% of normal rainfall) or have received excessive rainfall (+20% to +156% above normal). Key Kharif states like Easter UP, Bihar, Jharkhand, West Bengal, Maharashtra, and MP are deficient. Whereas, the western states of Rajasthan and Gujarat and the Northern states of Himachal, J&K, and Uttarakhand are in the large excess bracket. Key vegetable producing states like UP, Karnataka, Maharashtra, and West Bengal are highly deficient. Besides, the reservoir levels in the key state have fallen below long-term averages and could have some impact on Rabi crop also. Apparently, assumptions of early relief in vegetable & fruits, dairy, oilseeds, and pulses inflation are mostly based on hope.

The impact of the supply side intervention of the government post MPC meet, e.g., export duties on onions, and rice, etc., and release of onion buffer stock; fiscal support like subsidy on tomatoes, etc., could prove to be short-lived. Tax collections have started to weaken, further impeding the fiscal leverage for stimulating the economy.

Foreign flows have moderated in recent months. The pressure on INR is visible. The imported inflation, especially energy, could be a major challenge. Most global analysts and agencies are forecasting higher energy prices this winter due to depleted strategic reserves, continuing production cuts, and persisting demand.

One of the key drivers of the overall India growth story, viz., private consumption, does not appear to be in very good shape. High inflation and rates may keep the consumption growth subdued for a few more quarters at least. In any case, we are witnessing signs of heating up in personal loans and the housing market.

The other key driver of growth, the private capex, has shown some early signs of revival in the recent quarters. However, positive real rates, cloudy domestic consumption demand, and poor external demand outlook could hinder acceleration in private capex. The government is front-loaded its capex budget in the first half of the fiscal year in view of a busy election schedule in the second half. The assumption of growth acceleration may therefore be misplaced. In fact, the RBI has itself projected a much slower rate of growth for 2HFY24 and 1QFY25.

Recently, banking system liquidity has slipped into negative territory. Besides a hike in effective CRR, the RBI has been ensuring the withdrawal of ‘excess’ liquidity from the system. We may therefore see a hike in lending rates as MCLR for banks rises (even if the RBI stays put on repo rates) as we approach the busy credit season. The credit growth may be impacted due to this.

The war in Ukraine; the economic slowdown in China; and the monetary policy dilemma in the US and India are some examples of problems where the administrators and policymakers seem to be hoping for divine intervention. I see the recent speech of the US Federal Reserve Chairman Jerome Powell at the Jackson Hole symposium and the minutes of the last meeting of the monetary policy committee of the Reserve Bank of India in this light.

After 16 months of aggressive monetary tightening, the Fed is not confident whether they have done enough; or they have overdone with tightening or they are lagging behind. He reiterated that the policy is restrictive enough to anchor inflationary expectations, but still expressed fears that the high inflation might get entrenched in the economy and may require treatment at the expense of higher unemployment. Chairman Powell indeed sounded more like a sailor trapped in a storm, when he said, “We are navigating by the stars under cloudy skies”.

The situation in the US, as I see it from thirty-five thousand feet above sea level, is as follows:

·         The US Federal Reserve has hiked the key policy rates from near zero (0.25%) in March 2022 to 5.5% in August 2023. This is one of the steepest hikes in the past four decades.

·         The US financial system faces a serious challenge as MTM losses on the bond portfolios are accelerating; retail delinquencies have started to build up;

·         The positive real rates in the US are now 2% or higher. Despite these restrictive rates, the economy is not showing much sign of cooling down. The probability of growth acceleration in the US economy in the next couple of years is therefore remote.

·         Inflation continues to persist above 4% against a committed target of 2%. The household savings may therefore continue to shrink at an accelerated pace.

·         The mortgage rates are well above 7%, the highest in two decades. Housing affordability is at its worst in history.

·         The US government is paying close to US$1trn/year (about 20% of revenue) in interest on its borrowing, which is an unsustainable level.

·         The cost of borrowing (and interest burden) for the US government shall continue to rise for a few years at least as the Fed reduces its balance sheet, foreign governments cut on their demand for the US treasuries, and the rating of the US government’s debt face further downgrades. The fiscal pressures thus remain elevated.

·         The money supply (M1) in the US at US$19trn is about 4.5x of the pre-Covid levels. It may take years to normalize at the current speed of quantitative tightening (QT) by the Federal Reserve.

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The “Lower for Longer” narrative has metamorphosed quickly into “Higher for Longer”. However, analysts, economists, and strategists who are in their 30s may have never witnessed a major rate or inflation cycle in their professional careers. Their assessment of peak rates and peak inflation may be suffering from some limitations.

….to continue tomorrow

The current quarter (2QFY24) has witnessed disruptions due to challenging weather conditions. The southwest monsoon has been erratic both temporally and spatially. To date only about 43% of districts have received normal rainfall; whereas 40% of districts are deficient and 17% have received excess or large excess rainfall. Northern states have witnessed significant disruptions due to excess rains; impacting the logistics and crops. Besides, the festival season this year is pushed back by one month, pushing the festival demand to 3QFY24. Obviously, the outlook for consumer demand does not look exciting for the current quarter.

In this background, it is interesting to note the findings of the latest (July 2023) Consumer Confidence Survey (CCS) by the Reserve Bank of India (RBI). The key highlights of the survey are:

Present tense: After persistent recovery for almost two years, consumer confidence for the current period stood a shade lower than that witnessed in the previous survey round; improvement in respondents’ sentiment on income and spending was offset by somewhat higher pessimism on the general economic and employment situation.

Future hopeful: Going forward, households expect improvement in general economic, employment, and income conditions; they turned less pessimistic on one year ahead price situation vis-à-vis May 2023 round of the survey. The future expectation index (FEI) remained in optimistic terrain and recorded a marginal rise in the latest survey round.

Sentiments improving: Sentiments on current income improved further and moved to an optimistic zone for the first time in four years; future earnings expectations remain buoyant.

The current perception of the economic situation, employment, and inflation has worsened recently. It has persistently remained negative since July 2022.

The expectation for one year ahead regarding economic situation, employment, and spending has also worsened as compared to May 2023 survey. Though it still remains in positive territory, it has not shown any material improvement since July 2022.

It is fair to say that the future expectations of improvement are driven more by hopes rather than any substantive basis.

The political forces of all hues and colors have set out to join the battle for supremacy in 2024. Most non-political forces have also declared allegiance to the two primary alliances. There are few yet to join any of the main groupings; maybe they are waiting for some assurances about their roles during and after the battle. However, one thing appears certain – this battle is like the battle of Mahabharata, in which staying neutral is not an option.

The narrative and rhetoric

Both alliances are trying to set a narrative to influence the voters in preparation for the battle. As usual, the narratives are based on rhetoric and the promise of a better future. On the basis of several official statements, promotion campaigns, and media reports I decipher the following narratives and rhetoric to support these.

The NDA narrative could be briefly explained as – “Under the brilliant leadership of Prime Minister Narendra Modi, India is progressing fast to become a major global economic and strategic force; obliterating the decades of poor performance. Prime Minister has worked hard to end nepotism, corruption, & minority appeasement; and is putting India on the path to becoming an economically developed and socially just society. The opposition alliance on the other hand is a motley group of irrelevant political forces lacking any credible leadership that can match the charisma of prime minister Modi.”

The rhetoric to promote this narrative includes:

·         Prime Minister Modi is the most popular and charismatic leader in modern India.

·         The size of the Indian economy has grown exponentially in the past nine years of the NDA regime. Improvement in India’s global GDP rank to number five; the sharp acceleration in GST and Income Tax collection, and strong GDP growth despite a global slowdown are cited as key achievements of the incumbent government.

·         The stature of India has grown to unprecedented levels under the leadership of Prime Minister Modi. The successful Covid Vaccine diplomacy

·         Social schemes like Support money to farmers; Free food to 800 million citizens; Health Insurance for all BPL families etc. have transformed the lives of the majority of the population.

·         Infrastructure capacities have been built at an unprecedented pace in the past nine years. In particular, the construction of new highways and airports, expansion and electrification of the railway network, the introduction of faster and better trains, etc. are cited to highlight the achievements.

·         Abrogation of Article 370 of the Constitution, the Construction of a grand Ram Temple in Ayodhya, the beginning of the process of introduction of a Uniform Civil Code; and accelerated enforcement action on corrupt, etc. are cited to highlight the strong delivery performance of the incumbent government.

The I.N.D.I.A narrative could be briefly explained as - “Prime Minister Modi is leading a totally corrupt, divisive, opaque, oppressive, and undemocratic government. A few ‘friends’ of the prime minister have been favored to the detriment of the national interest. The society has been deeply divided on the basis of religion and caste. There is no transparency in the operations of the government. The leadership is misusing the state enforcement agencies to oppress the opponents. The spirit of federalism has been compromised as resource flow to the states being government by non-NDA parties is constricted and the existence of many of these governments is consistently threatened. Hence, the NDA alliance is not conducive to the very idea of INDIA.”

The rhetoric to promote this narrative includes:

·         The meteoric rise of certain industrial groups, considered close to the NDA leadership in the past nine years.

·         The country has witnessed a significant rise in communal tension in the past nine years. The secessionist forces have gathered strength in the past nine years.

·         Many duly elected state governments have been displaced using unfair means.

·         The government has miserably failed to deliver on its promise of inclusive growth as inequalities have risen sharply in recent years.

·         The government mismanaged the Covid-19 pandemic.

·         The government has mismanaged the price (inflation) situation in the country thus adversely affecting the poor people most. Besides, the government has failed to deliver on the promise of providing employment.

·         The NDA has inducted a large number of opposition leaders it has been accusing of corruption. It has threatened opposition leaders and parties of enforcement action to gain their support.

·         The government has compromised national security, allowing China to intrude in the Indian territories.

·         The government has been opaque in many important matters like electoral bonds, PM Cares Fund, Rafael Deal, etc.

·         The government lacks federal spirit.

·         The government has not only failed to protect women but has also harbored many accused of abusing women. The rise in crime against women and communal violence has undermined the global reputation of India.

It is obvious that the narrative is built around the problems being faced by the country. The most unfortunate part is that no one is bothering to offer any solution. We have not heard much about the solutions. For example, almost every citizen of the country is aware of the inflation problem. No one needs to be told about this problem. What they want to know is how this problem would be resolved.

In the subsequent posts, I shall list the problems that need to be resolved and also suggest some solutions.

Besides hiking the policy repo rate, RBI also enforced correction in banking system liquidity to check the demand side pressures on inflation. The banking system liquidity that was running in excess of rupees eight trillion a year ago, has been completely neutralized.

Impact of monetary tightening

It is very difficult to assess the direct impact of the RBI’s monetary policy action and its consequences. Nonetheless, it is pertinent to note how various sub segments of the economy have moved in the past one year. This movement could have been caused by a variety of factors, RBI tightening being one of them.

Inflation

The Consumer Price Index Inflation (CPI) has eased from 7.04% (yoy) in May 2022 to 5.66% (yoy) in March 2023. After mostly staying above the RBI tolerance band of 4% to 6% for more than 15%, the latest inflation reading is within the band, though still closer to the upper bound. If we adjust it for high base effect, material easing in global commodity prices, and significant improvement in supply chains, in the past one year, the direct impact of RBI policy on demand side pressure may not be material. Besides, given the chances of a below par monsoon due to development of El Nino in the Pacific Ocean, the food inflation may spike again challenging the sustainability of the recent fall in CPI inflation.

Money supply and credit

In the past one-year broader money supply (M3) in India has grown at a higher pace than the trend seen in the past one decade; and currently stands at INR227.8trillion.

The commercial banks have not passed on the entire 250bps hike in the policy repo rate to the borrowers. On average lending rates have risen 130 to 150bps. It is pertinent to note that movement in lending rates in India is mostly not in tandem with the policy repo rates. Lenders were also slow in cutting the rates while RBI was in easing mode. Regardless, now since the RBI has already signaled a pause, the probability of material rise in lending rates from the current level is low; implying that the policy rates are more of a signaling tool rather than a driving force for the commercial rates. The commercial rates are more of a function of demand and supply.

In FY23, the overall bank credit grew from Rs118.9trillion to Rs136.8trn, registering a growth of 15%, highest since 2014. Though some moderation in credit growth has been seen in the past one quarter.

The fastest growing segments of the bank credit in the past one year have been personal loans (especially unsecured loans) and financing to NBFCs, (much of this could also be consumer financing related). This clearly suggests that higher rates may not have deterred the demand much.

Growth

There is little evidence to show that the tighter monetary policy of the RBI in the past one year may have directly impacted the economic growth materially. Nonetheless, the growth momentum has definitely slowed down and is not seen picking up from the present low levels in any significant manner over the next 12months. Though the RBI has forecasted FY24 real GDP to grow at 6.4%; most private forecasters estimate the growth to remain slightly below 6%. Declining global growth and poor weather conditions could be the two major factors in the lower trajectory of growth.

Yield curve

The benchmark 10yr bond yields in India are now at the same level as these were a year ago. The short to mid-term yields (30days to 5yr) have risen sharply in the past one year. In the past six month in particular, the overall yield curve has moved down noticeably, except in the 30days to 1yr timeframe where the yields are still higher. Apparently, the poor liquidity in the banking system has resulted in higher near term rates, without impacting the demand materially – more of a lose-lose situation.

To conclude, I would believe that the aggressive tightening by RBI in the past one year, was more of a reaction to the global trend, ostensibly to preempt the outflows and pressure on INR, rather than to stabilize prices and calibrate demand. Given that USDINR has weakened by over 7% in the past one year; and foreign investors have been net sellers in the past twelve months, it could be concluded that RBI would have been better pursuing an independent monetary policy commensurate with the assessment of local conditions and requirements.

I understand the “not for this, things could have been much worse” argument fully and will reply to that some other time.

Over the weekend I examined more than twenty-five investment proposals, mostly focusing on elevated inflation and its impact on real returns. The common advice is to take higher risk by increasing the proportion of high yielding debt and equities.

Discussions with investment advisors indicate the investment strategies aimed at protecting the real (inflation adjusted) value of the investors’ portfolios may be based on poor, and often wrong, understanding of the impact of inflation on investors. Most of them presented the official data of inflation and suggested investment products that may yield a return that is higher than the official CPI (Consumer Price Index) inflation.

None of the 20 odd investment advisors I spoke with has considered that inflation is a very personal phenomenon. Every investor may have a different inflation number to deal with. The official CPI inflation may be of little relevance for a majority of household investors. The inflation affects rural and urban investors differently. The inflation also varies according to the State, an investor lives in and incurs most of the expenditure. The impact of inflation on investors’ wealth could be different depending on his consumption pattern and saving propensity.

·         The inflation rates for various states are different. In March 2023, West Bengal CPI inflation was just 4%, as compared to national average of well over 5% and Tamil Nadu inflation of 7%. Investment strategy for investors living in Kolkata and Chennai need to account for this difference.

·         The weightage of different states in calculation of CPI is also different. Maharashtra has a weightage of 13% (8% rural and 19% urban) in overall CPI basket; while Bihar has a weightage of 5%. Obviously, the investors in Patna and Mumbai face different inflationary impact; and their investment strategies to fight inflation need to be different.

·         The weightage of food and beverages in rural CPI basket is 54%, while in urban basket it is 36%. The combined basket has a weight of 46% for food. Obviously, food inflation impacts rural and urban investors differently. Rural basket has 3% weightage for Pan, tobacco and other intoxicants while urban basket has a weight of 1% for this. Similarly, the weightage of education, health and dairy consumption also varies sharply for rural and urban consumers.

·         The official CPI basket does not account for the inflation in housing and rental cost, which could be a significant expenditure for many investors, especially in urban areas.

·         One of the most important aspects of inflation consideration in investment strategy should be the saving propensity of the investor. An investor which is able to save 60-70% of his income cannot be put n the same bracket as an investor who saves just 10-20% of his income.

·         The investors who have significant debt and use most of their savings to repay the debt may have a self-neutralizing inflation. Similarly, an investor engaged in a money lending business might be much more severely impacted by inflation than investors who have significant borrowing.

·         A 70yr old investor with independent children, who consumes less cereals, education and transportation and more healthcare will have very different inflation impact as compared to a 40yr old investor with school going children and dependent aged parents will have remarkably different consumption basket and therefore inflation impact.

The point is that the impact of inflation is usually different for various investors depending on their individual circumstances and status. Therefore, investment strategy needs to be personalized for all investors, or at least class of investors. Selling the fear of inflation and making them invest in products which are benchmarked to official CPI may not serve much useful purpose for most of them.

Investors also need to understand their inflation profile and accordingly adjust their investment strategy.