Vijay Kumar Gaba

 Sitharaman, Powell toss the ball in Das’s court

Wednesday night, the Federal Open Market Committee (FOMC) decided to maintain the status quo on policy rates for the fourth successive review. The Committee reiterated that it “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward two percent.” The Committee however made it quite clear that any rate hike from the present level is no longer on the table.

In the post-meeting press meeting, Fed Chairman Jerome Powell indicated that FOMC may not consider rate cuts in its next meeting in March 2024. The market is thus expecting a rate cut in May 2024.

In another development, the Union Finance Minister, Ms. Nirmala Sitharaman, presented an interim budget for the fiscal year 2024-25. Two notable features of the interim budget were (i) Nominal GDP growth projection for FY25 at 10.5%, implying a well-controlled inflation environment; and (ii) Fiscal deficit of 5.1% of GDP for FY25BE, implying a strong commitment to fiscal discipline.

In line with the lower fiscal deficit projection, the borrowing program of the government has also been moderated. The finance minister has proposed Rs11.75trn of net borrowing from the market by way of fresh government securities in FY25BE against Rs11.80 borrowed in FY24RE. This shall leave decent scope for private investment.

In her speech, the finance minister also emphasized the supportive environment her government is building for acceleration in private capex to achieve the high growth targets. The minister has provided higher allocation for production-linked incentives (PLI).

With the global rate and monetary policy environment set to become benign in 2H2024; domestic macro (fiscal deficit, inflation, external conditions, etc.) improving and the government holding its side of promise to maintain fiscal discipline despite forthcoming general elections, the ball is now in the court of the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) to provide impetus to the economic growth.

The risks to inflation now mostly stem from food (inclement weather) and energy (geopolitical disruptions) which may not have a significant correlation with the policy rates. It would therefore be in order for RBI to guide a lower rate path and increase system liquidity.

The MPC meeting next week therefore will be watched with keen interest. I would not expect any immediate rate cut (though it will be welcome if happens), a clear guidance for lower rates going forward and enhanced system liquidity is what I do expect from MPC. If RBI delivers on these expectations, markets could rally to new highs led by financials and rate-sensitive sectors like auto and real estate.

From the Bollywood movie ‘Chak De India’ (Dir. Shimit Amin, 2007), the climax sequence has been particularly popular. It is perhaps one of the most popular, inspiring, and quoted pieces of Indian cinema. In one part of the climax, the protagonist (played by Shah Rukh Khan), who is the coach of the Indian national women’s hockey team, is guiding the team in the World Cup final match against the defending champion Australia. During a penalty shootout, the coach tries to anticipate the penalty shot of the Australian striker by reading her body language – leg position, eyes, hockey stick and wrist position etc. – and correctly concludes that the striker will hit the ball straight and guides the Indian goalkeeper to stay still in the middle of the goal post. The goalkeeper saves the critical penalty and India wins the match.

Recently released minutes of the meeting of the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) highlighted that the latest policy stance is primarily ‘Wait and Watch”. This stance is driven by the hopes of:

(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.

 

 RBI monetary policy statement highlights

·         Status quo on policy rates and monetary policy stance (withdrawal of accommodation).

·         The MPC resolved to continue keeping a close vigil on the evolving inflation and growth outlook. It will take further monetary actions promptly and appropriately as required to keep inflation expectations firmly anchored and to bring down inflation to the target. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth.

·         Domestic economic activity remains resilient in Q1:2023-24 as reflected in high frequency indicators. Purchasing managers’ indices (PMI) for manufacturing and services indicated sustained expansion, with the manufacturing PMI at a 31-month high in May and services PMI at a 13-year high in April-May. In the services sector, domestic air passenger traffic, e-way bills, toll collections and diesel consumption exhibited buoyancy in April-May, while railway freight and port traffic registered modest growth.

·         On the demand side, urban spending remains robust as reflected in indicators such as passenger vehicle sales and domestic air passenger traffic which recorded double digit growth in April. Rural demand is gradually improving though unevenly.

·         Money supply (M3) expanded by 10.1 per cent y-o-y and non-food bank credit by 15.6 per cent as on May 19, 2023. India’s foreign exchange reserves were placed at US$ 595.1 billion as on June 2, 2023.

·         Going forward, the headline inflation trajectory is likely to be shaped by food price dynamics. Assuming a normal monsoon, CPI inflation is projected at 5.1 per cent for 2023-24, with Q1 at 4.6 per cent, Q2 at 5.2 per cent, Q3 at 5.4 per cent and Q4 at 5.2 per cent. The risks are evenly balanced.

·         The government’s thrust on capital expenditure, moderation in commodity prices and robust credit growth are expected to nurture investment activity. Weak external demand, geoeconomic fragmentation, and protracted geopolitical tensions, however, pose risks to the outlook. Taking all these factors into consideration, real GDP growth for 2023-24 is projected at 6.5 per cent with Q1 at 8.0 per cent, Q2 at 6.5 per cent, Q3 at 6.0 per cent, and Q4 at 5.7 per cent, with risks evenly balanced.

·         The next meeting of the MPC is scheduled during August 8-10, 2023.

Credit Growth Remains Strong in April 2023, Industry Subdued (CARE Ratings)

Gross bank credit offtake rose by a robust 15.9% year on year (y-o-y) in April 2023 due to continued strong growth in services and personal loans especially driven by growth in lending to Non-Banking Financial Companies (NBFCs), vehicle loans, and unsecured personal loans1 segments.

·         Credit growth for the services segment was robust at 21.8% y-o-y in April 2023 as compared with 11.2% a year-ago period due to growth in NBFCs, retail trade and other services.

·         Personal loan growth accelerated by 19.4% y-o-y in April 2023 from 14.4% a year-ago period, driven by credit cards, housing, vehicle loans and other loans.

·         Industry credit offtake growth moderated at 7.0% (y-o-y) from 8.0% over a year ago, registering a lower growth compared to personal loans and services. Infrastructure witnessed a marginal rise of 1.7% due to growth in roads and others, however, power, ports, airports, and telecom dropped in the month.

·         Agriculture and allied activities rose by 16.7% in April 2023 vs. 10.6% in April 2022.

FY23 Corporate performance insights (Bank of Baroda)

FY23 Growth in sales was steady though lower than last year. Growth in net profits has slowed down for both the aggregate sample as well as the one which excludes BFSI companies. The difference from the past is that growth in net profit margin is positive indicating some recovery.

Table 1 reveals that growth in sales has slowed down from 21% in Q4-FY22 to 12% in Q4-FY23 for the sample of 2096 companies while that in net profits has moved from 26.1% to 17.3% during this period. There has been improvement in net profit margin in both the years.

Table 2 excludes BFSI companies. Here the performance is relatively muted with sales growth of 8.8% and net profit of 7.5%. The higher base effect as well as dilution of pent up demand in some sectors contributed to this slower growth. The net profit margin however has been falling over the last two years of this quarter though the dip in Q4-FY23 has been very marginal.

A significant observation here is that the interest cover ratio for the sample of 1797 companies came down to 5.82 from 6.45 last year after witnessing an improvement in FY22. This was a result of both lower growth in PBIT as well as higher interest costs due to the lending rates increasing in the banking system. PBIT had grown by just 4.8% this quarter compared with 9.4% last year. However, interest costs increased sharply by 16.3% compared with 4.7% in Q4-FY22.

 - The industries which grew at a higher rate than the average were: banks, insurance and Finance in the BFSI sector. Services received a boost from the pent up demand which got reflected in hospitality, diamonds and jewellery, logistics, IT, retail, and trading. Within manufacturing auto did well on the consumer oriented front while construction material, power and industrial gases performed positively on the industrial front.

- Low growth was witnessed in case of textiles, alcohol, plastic products, mining, gas transmission and iron and steel.

- Food based products and health care had maintained their sales growth at the average level which was also the case with paper.

- Industries like electricals, FMCG, chemicals, infra, capital goods, media, telecom, realty, consumer durables registered single digit growth. Price pressures did come in the way of demand; and rural demand was less robust than expected across some of these industries.

Real estate (Kotak Securities)

Cautious road, treading between vacancies and occupancies: Commercial real estate in top Indian cities is facing headwinds despite improved quarterly leasing. Existing vacancies are primarily in SEZ areas, which may be hard to fill up until the regulatory amendment comes through, while current occupancies have a large presence of IT companies, among which Cognizant is taking the lead to rationalize the need for office space among key Indian cities. In that backdrop, FY2024E may not be able to repeat the strong showing of FY2023, which saw leased area increase to 524 mn sq. ft, with record absorption (78 mn sq. ft/39 mn sq. ft of gross/net leasing). Yields have improved due to price correction, but visibility on FY2024E remains lackluster.

Healthy gross and net absorption, new supply falls further: All-India commercial real estate (aggregate of top 7 cities) had an outstanding stock of 615 mn sq. ft (+7% yoy, +1% qoq) as of March 2023, with gross absorption a tad lower on a sequential basis but still healthy at 18.4 mn sq. ft (+1% yoy, -8% qoq). Net absorption during the quarter stood at 9.4 mn sq. ft (+14% yoy, -1% qoq), while new supply in 4QFY23 slowed further to 7.6 mn sq. ft (-38% yoy, -11% qoq). Consequently, vacancy declined 2% qoq to 90.6 mn sq. ft, with vacancy improving to 14.7% (15.4% in 4QFY22 and 15.2% in 3QFY23).

Among cities, Gurgaon led the improvement in occupancy, with gross and net absorption of 2.3 mn sq. ft and 1.1 mn sq. ft, respectively, and nil new supply during the quarter. Accordingly, vacancy declined to 26.1% in 4QFY23 (27.4% in 4QFY22 and 27.3% in 3QFY23). Mumbai also saw an improvement, with net absorption and new supply at 1.3 mn sq. ft and 1.2 mn sq. ft, respectively, and vacancy at 15% (17.7% in 4QFY22 and 15.3% in 3QFY23). Bengaluru saw a slight increase in vacancy to 6.9% (from 6.8% in 3QFY23, 4QFY22 at 7.5%), as net absorption of 2.2 mn sq. ft lagged new supply of 2.6 mn sq. ft. Hyderabad, Pune, Noida and Chennai saw net absorption of 1.7 mn sq. ft, 1.8 mn sq. ft, 0.7 mn sq. ft and 0.6 mn sq. ft, against new supply of 1.1 mn sq. ft, 1.2 mn sq. ft, 1.5 mn sq. ft and nil, respectively. Blended rentals saw sequential moderation (+4% yoy, -6% qoq)—most large cities saw a correction. Total leased area rose 8% yoy and 2% qoq to 524 mn sq. ft as of March 2023.

SEZ clarification key for further occupancy improvement: Commercial asset owners suggest that the demand scenario is robust, with rising occupancy across geographies. Clarity on the DESH bill and allowing floor-by-floor de-notification are key, although any occupancy improvement would take at least 2-3 quarters post the amendment as the non-SEZ occupancy is already at 93-94% levels for most asset owners. Accordingly, an improvement in overall occupancy should only be very gradual hereon. Exhibit 4 highlights the break-up of vacancy between SEZ and non-SEZ areas. In our view, even if the regulatory amendment comes through in 1HFY24, the process of de-notification and leasing of vacant spaces will only close by end-FY2024.

Leasing trends: GCC expansion to offset some weakness in IT but overall improvement may take time Cognizant has announced its plans to vacate 11 mn sq. ft of space in tier-1 and metro cities (with subsequent plan to acquire space in smaller cities), we would watch out for commentary from other large employers (tech, BFSI) for cues. For now, asset owners see the Cognizant announcement as a part of regular business, stating that the vacancy should happen only gradually, while also offering asset owners the opportunity to mark-to-market the rents in some of their old contracts. Data on non-software service exports corroborates the strength in GCC growth in India—assets owners remain optimistic that GCC strength will help absorb any release of office spaces by technology companies, and also help improve overall rent rates for their portfolios. IT companies have seen a slowdown in hiring over the past few quarters, with 4QFY23 seeing a decline in headcount across tier-1 IT companies in comparison to expansion in every quarter since the beginning of the pandemic. Global Capability Centers (GCCs) continue to expand in India, especially in Bengaluru.

Electrodes: Demand Headwinds Likely to Impact Near-Term Pricing (Jefferies)

Weak demand (global & domestic) impacted Electrode pricing and utilization in Q4FY23. Exports are ~70%/50% of HEG/GRIL's sales. We foresee demand headwinds to persist in FY24e, and lower our est for electrode ASPs and utilizations (now to ~65%) for both cos. We cut

FY25-26e EBITDA by 8-16%, but expect higher impact in FY24e. Beyond the near-term headwinds, decarbonization stays a medium-term tailwind; 7mnMT EAF capacity has commissioned in US in last 12M. Buy.

Demand Headwinds Persist: In FY23, global crude steel production dipped by 4-5%YoY amid weaker offtake across many regions. But Indian production grew by 5-6%YoY. Domestic demand accounts for ~50% of GRIL's sales mix, but is lower at ~30% for HEG. Weak global offtake impacted HEG's capacity utilization to 75% in FY23 (-1,200bps YoY). Electrode pricing has also declined by ~3%QoQ in Q4. Industry channel inventory is est to be higher-than-normal currently. We foresee demand headwinds to continue in FY24e as well, and hence cut our estimates for electrode ASPs and utilizations for both companies. HEG's 20K MT extra capacity is likely to commission in Jun'23. While we expect HEG's FY24e utilization to decline to 65% (75% in FY23), absolute volumes could grow by +10%YoY due to its higher total capacity now at 100K MT. We cut GRIL/HEG's capacity utilization by -10%/-14% resp in FY24e to 65-66%, but pencil in revival to 75-80% in FY25e led by a recovery in demand.

EBITDA Pressure: Softer demand offtake (lower volumes) and weaker pricing are likely to impact EBITDA margins of both GRIL & HEG. Resultant impact on EBITDA is est to be higher in FY24e than in FY25-26e. Needle Coke (NC) prices are also softening, but the drop in electrode pricing is likely to be higher than NC in FY24e. We cut electrode cos' FY25-26e EBITDA by 8-16%, while FY24e cut is est to be sharper owing to steeper cut in utilizations and pricing. We est FY24e EBITDA margin at +12%/16% for GRIL/HEG resp.

Decarbonization - A Medium-Term Tailwind: Exports account for ~70% of HEG's sales mix, and ~50% for GRIL. While global EAF steel production is 45-50% ex-China, China is still lower at low-double-digit (2x since 2016). US is ~70% EAF production now, and now accounts for ~10% of HEG's sales mix, having risen 2-3x in the last 4 years. New EAF capacity of ~7mnMT has already commissioned in last 12M, and incremental ~17mn MT of EAF is expected to commission in the USA in the medium-term.

India Pharma: Moats intact, volume recovery key (Axis Capital)

Promising trends: strong pricing, growth in chronic/ new-age drugs IPM grew a steady 9% YoY in FY23 (3-year CAGR at ~9%) after 2% /15% Covid-affected growth in FY21/22. Despite various disruptions (GST, NLEM*, Covid, etc.), IPM has seen steady ~10% growth over the past 10 years led by volume (despite the impact of trade generics, Jan Aushadhi, etc.), price hikes (higher inflation) and new launches (following the expiry of patent exclusivities). Key trends:

Price growth is likely to remain high, at 5-6%, due to the 12.1% hike taken in NLEM products (~14% of IPM) and ~5% hike on the rest in the wake of inflation.

Volume growth in Chronic has started to improve after a dip in demand due to Covid fatalities in the co-morbid cohort. Within Acute, a strong flu season saw the recent recovery in anti-Infectives/ Respiratory, which had moderated post the Covid spike.

Growth in Respiratory is led by price and volume, while growth in Cardiac is largely led by price hikes with tepid volume growth.

Prescription growth in traditional anti-Diabetes is slowing, while new-age molecules like DPP4, SGLT2 and combinations are picking up, increasingly prescribed by general practitioners (GPs) in addition to conventional prescriptions by specialists.

India formulations– superior business model: India sales (20-100% of company sales) remain the key earnings contributor for most pharma companies due to steady growth visibility, higher return ratios, and superior FCF. Notably, branded generic models allow for price increases (to help offset rising costs). We expect domestic-focused companies to outperform IPM growth given:

Focus on building mega brands (sales of Rs 500 mn to Rs 2+ bn)

Expanding field force – to increase coverage in newer markets (tier 2/3 cities)

M&As (strong balance sheet) that can fill gaps and augment existing therapies

Risk from pricing control/ generics – limited impact: NPPA’s price control list, last revised in Dec’22, has partially impacted Q4FY23 growth –which pharma companies expect to counter with increased volumes (given strong brands) and price hikes (from Apr’23). Pricing policies are unlikely to impact sales beyond a point given competitive pricing by most. Trade generics, private label and Jan Aushadhi are seeing a brisk ramp-up in sales, however, this model faces challenges in supply, SKU shortages and concerns regarding quality from patients and doctors. More inside: market shares, companies (not covered, not listed as well)

Market share across therapies, companies, brands, bonus contribution, NLEM, Jan Aushadhi, trade generic coverage, etc.

Snapshots on major pharma companies highlighting (a) 5-year trends in volume, price and new introductions, (b) market share/other trends across key therapies/brands, (c) trends in Chronic vs. Acute mix, etc.

Specialty chemicals: Growth continues to moderate (nuvama institutional equities)

Overall, sales for the sector grew a mere 6% YoY/3% QoQ, driving EBITDA growth also at 6% while maintaining EBITDA margins at 22%. Demand for specialty chemicals catering to agrochem innovators such as PI and SRF remains strong while players catering to generic molecules witness weakness as supplies from China increases. Fluorpolymers demand remained strong; however, refrigerant gas prices have started softening. Overall, trends in specialty chemical demand remains weak as softening RM prices are leading to inventory liquidation across the channel.

Multiple headwinds hamper FY24 growth: Refrigerant gas players such as SRF, Gujarat Fluoro gave cautious commentary on softening refrigerant gas prices; however, specialty chemicals catering to agrochem (PI, SRF, Anupam Rasayan) remains confident of ~20%-plus growth. Players with higher share of commodity – Aarti, Deepak Nitrate and Jubilant Ingrevia continue to maintain weak commentary as demand from end-user industry remains sluggish.

However, they expect a pickup in H2FY24. FMCG-led players like Galaxy and Fine Organics are seeing strong demand in domestic market; however, facing challenges in Europe and US given the inflationary scenario and inventory liquidation.

Outlook and valuation: Growth moderation factored in: Most players set a cautious tone on the back of: i) inventory liquidation impacting demand; ii) slowdown in markets like Europe and US; and iii) price correction in categories like refrigerant gases. However, the industry is witnessing strong domestic demand and growing enquiries in exports as global players continue to look for alternatives to China and increasing outsourcing to reduce cost.

We acknowledge headwinds in FY24 – factored in to our estimates. We expect growth driven by sustained capex, FY25 to witness growth revival while current valuations (sector average at 23x Y25E P/E) limit downside.

 The Monetary Policy Committee (MPC) is currently holding its bi-monthly meeting. This particular MPC meeting is perhaps one of the least discussed by the market participants. There is not much anticipation about the outcome that will be known tomorrow morning. The consensus overwhelmingly believes that RBI will maintain the status quo on rates and monetary policy stance.

A quick reference to a note prepared by the research team of the State Bank of India would be apt to highlight the extent of the lack of excitement amongst market participants over this MPC meet. The SBI team devoted three full pages to verify a humorous US study that correlates the height of Fed chairman to the rate hikes and discovered that incidentally it is true in the case of India also.

Though the market is divided in its expectation about the course of action the Federal Open Market Committee (FOMC) of the Federal Reserve of the US would take in their meeting scheduled on 13-14 June 2023; few expect a 25bps hike by the Fed would have any bearing on the RBI decision making. To that extent RBI policy making effort may have already diverged from the developed market central bankers, particularly the US Federal Reserve.

The reasons for this divergence in the direction of monetary policy are obvious – strong growth data; inflation within tolerance range; stable bonds and currency markets; comfortable liquidity; positive foreign flows; much improved current account; and better than expected corporate performance. Specter of an erratic monsoon is definitely a red flag; but it may influence the timing to begin easing the monetary policy rather than the decision to maintain the status quo. 

I find it interesting to note that economists are not bothered to mention the probability of the MPC to consider accelerated tightening due to heating of economy, especially given the GDP growth has outpaced RBI’s own much above consensus forecast; spike in unsecured personal loans; and sharp rise in real estate prices in most urban and semi urban pockets.

Like market participants, I am not eagerly waiting to hear what the governor Das has to say on the MPC decision tomorrow morning. Nonetheless, I would be keenly watching if the RBI takes some precautionary steps to check unsecured personal loans and credit to the real estate market. I am also not keen to look for a hint of rate cut in the August meeting, though the real rates are now in the territory where these could constrict growth.

 The market has generally responded to the RBI pause on rate hikes positively. The financial sector stocks, especially non-banking lenders, have attracted particular interest from investors and traders. The analysts have also been marginally positive on the sector post the shift in RBI stance.

The RBI, in its latest policy statement, (i) paused the streak of rate hikes; (ii) maintained the “withdrawal of accommodation” monetary policy stance; (iii) upgraded the GDP growth estimates for FY24; and (iv) indicated inflation to stay closer to upper bound of policy tolerance range (4-6%) with upside risks.

For a common small investor like me this translates into the following:

(a)   Banks may find it hard to hike lending rates, especially the floating rate loans indirectly pegged to the policy rates. It is pertinent to note that most banks did not pass on the entire repo rate hike of 225bps done in the past one year, to the borrowers.

(b)   The liquidity may continue to be tighter, while growth remains buoyant. Strong growth may lead to further widening of the deposit-credit gap, pressuring the deposit rate. The margins of banks may not expand from the current levels. In case of weaker franchises, margins may actually decline in the next 3-4quarters.

(c)   Elevated inflation may deny any probability of rate cuts this year – minimizing the probability of any exceptional treasury gains or lower cost of funds.

Thus, re-rating of the financial sector stocks as a whole may be over. After a sharp outperformance of public sector banks, we may see a shift back to quality private sector banks. NBFCs which are able to manage their credit cost better will be in favor as margins remain under pressure. It is also pertinent to note that weather agencies are forecasting a hot summer and less than normal rains. This could impact the repayment capability of rural borrowers to some extent.

In view of this I shall be moderating my strategy stance on financials from overweight to equal weight. I shall in particular reallocate from PSBs to large private sector banks and from MFIs to large diversified NBFCs.

The Reserve Bank of India has increased the policy repo rate six times in the current financial year (FY23). It has continued to withdraw excess liquidity from the financial system through various means and has mostly maintained a hawkish demeanor, insofar as the policy outlook is concerned.

In spite of (i) aggressive rate hikes; (ii) withdrawal of excess liquidity from the system; (iii) sharp correction in global commodity prices (especially energy); (iv) restoration of supply chains that had got damaged during pandemic resulting in severe supply shortage of key raw materials and inputs; (vi) three consecutive normal monsoon seasons yielding bumper crops; and (vi) slow growth – CPI inflation has persisted above the RBI tolerance range of 4 to 6% and credit growth has accelerated and remained strong. Obviously there is a disconnect somewhere. Even one third of the members of the Monetary Policy Committee of the RBI do not agree with the policy stance of the RBI and have voted against rate hikes.

Personal loans and working capital demand driving credit growth

In a recent report rating agency CARE Ratings highlighted that “Credit growth has generally been trending upward throughout FY23 and remained robust in recent months even amid the significant rise in interest rates.” The report pointed that “Retail and NBFCs have been the key growth drivers for FY23. Besides, demand for capex too is expected to drive industry credit growth.” As per the agency, “Incremental credit growth has risen by 12.2% so far in FY23. In absolute terms, credit expanded by Rs.14.5 lakh crore from March 2022. The growth has been driven by continued and sustained retail credit demand, strong growth in NBFCs and inflation-induced working capital requirement”.

Personal loans, driven by housing and vehicle loans, continue to be one of the fastest growing segments of credit growth. Even in December 2022, “Personal loans grew by 20.2 per cent (y-o-y) in December 2022 from 14.9 per cent a year ago, largely driven by housing and vehicle loans.”

 

 Banking system liquidity turns negative from a large surplus

The banking system liquidity has been quickly evaporating in FY23. From a large surplus a year ago, the banking system liquidity has turned negative in recent weeks. As of January 27, 2023, the banking system liquidity deficit stood at Rs.18,916 crore as against a surplus of Rs.6.4 lakh crore at the beginning of FY23.

Credit growth outpacing deposits

For the fortnight ended January 27, 2023, deposits with scheduled commercial banks (SCBs) stood at Rs177.2trn. The current deposit base is higher by Rs12.5trn as compared to the beginning of FY23. Bank deposits growth continues to lag the credit growth resulting in gradual rise in credit to deposit ratio.

 

Conclusion

From a plain reading of the above mentioned data points and corroborating evidence, I am drawing the following conclusions:

·         The economic growth continues to be highly skewed (K shaped)

The top decile of the population seems to have emerged economically stronger from the pandemic. Record high spend on foreign travel; record sales of high end cars; 9yr high sales of premium homes; are just a few indicators of this trend.

On the other hand, the middle classes have struggled to sustain their pre-pandemic lifestyle. Their savings are depleting; credit card outstanding and rolling credit is rising; and high inflation is hitting their consumption.

The reliance of poor people for essentials like food, shelter, healthcare, education on government is intensifying. Over 800million people are now availing free food.

·         Rates could rise further

Persistent inflation, neutral to negative liquidity, high current account deficit (INR under pressure), slowing household savings rate, and credit demand outpacing the deposits imply that the overall environment for rates remains bullish. We may see deposit and lending rates rising further; while the policy rates stay elevated. A pause by RBI may not result in lowering of rates in the short term.

·         Growth to remain suboptimal, private capex may remain in slow lane

There is evidence that high real rates may have started to constrict economic growth in India. The real GDP growth in FY24 is forecasted to be 5.8% to 6% by most economists and analysts, though RBI has projected an optimistic 6.4% in its latest monetary policy statement. Private capex may thus remain in the slow lane despite optimistic projections.

·         Banks’ margins may take a hit

In the past one year Indian banks have enjoyed strong margins as loans were repriced in tandem with the policy rates. The deposit rates usually get repriced with a lag. We shall see deposit rates rising in the next few quarters impacting the margins of the banks.

·         Economic inequalities may rise further

With inflation, high rates, slower economic growth (poor employment generation) continuing to hit the middle classes and poor hard, we shall see the economic inequality continuing to rise further. The consumption of the premium segment may sustain and grow faster as compared to staples and essentials.

 The Reserve Bank of India (RBI) governor declared victory for its policy stance in unambiguous terms while presenting the latest monetary policy statement. He stated, as a result of various policy measures taken by RBI since April 2022 “the real policy rate has been nudged into positive territory; the banking system has moved out of the Chakravyuh of excess liquidity; inflation is moderating; and economic growth continues to be resilient”.

MPC remains predictive – 25bps hike with stance unchanged

The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) in its meeting held over the past three days decided to hike the policy repo rate by 25bps to 6.75%. The decision was taken by a majority vote with four members voting in favour and two members voting against the hike. The MPC also maintained its monetary policy stance of withdrawal of accommodation with a split vote of 4 to 2.

The decision of the MPC and voting pattern is mostly in line with the consensus forecast. The equity market nonchalant post the predictable policy statement was made public; while bonds witnessed some sell-off.

Notwithstanding the stance of a divided MPC, the RBI moderated its inflation forecast for FY24 to 5.3% and enhanced their real GDP growth forecast for FY24 to 6.4%. The growth projected for 1QFY24 is 7.8%; which appears rather optimistic under the current circumstances. Even for the full year FY24 the market consensus is close to 6%.

Rate hike and tightening to break persistence of inflation

While acknowledging that global inflationary headwinds are subsiding; food inflation outlook is encouraging; CPI inflation for FY24 is expected to remain within RBI tolerance band of 4 to 6% throughout the year; and substantial reduction in surplus liquidity in the financial system - a majority of MPC decided to hike the policy rates and also to continue with withdrawal of accommodation, ostensibly to “break the persistence of core inflation”.

Growth remains resilient

Available data for Q3 and Q4:2022-23 indicate that economic activity in India remains resilient. Urban consumption demand has been firming up, driven by sustained recovery in discretionary spending;, and rural demand continues to show signs of improvement as tractor sales and two-wheeler sales expanded in December.

Investment activity continues to gain traction. Non-food bank credit expanded by 16.7 per cent (y-o-y) as on January 27, 2023. The total flow of resources to the commercial sector has increased by ₹20.8 lakh crore during 2022-23 so far as against ₹12.5 lakh crore a year ago.

On the supply side, agricultural activity remains strong with good rabi sowing, higher reservoir levels, good soil moisture, favourable winter temperature and comfortable availability of fertilisers.5 PMI manufacturing and PMI services remained in expansion at 55.4 and 57.2 respectively, in January 2023.

Growth outlook: Real GDP growth for 2023-24 is projected at 6.4 per cent with Q1 at 7.8 per cent; Q2 at 6.2 per cent; Q3 at 6.0 per cent; and Q4 at 5.8 per cent. The risks are evenly balanced. Key risks: Pprotracted geopolitical tensions, tightening global financial conditions and slowing external demand

Core inflation sticky

Headline CPI inflation moderated by 105 basis points during November-December 2022 from its level of 6.8 per cent in October 2022. Core CPI inflation (i.e., CPI excluding food and fuel), however, remained elevated.

Considerable uncertainties remain on the likely trajectory of global commodity prices, including price of crude oil. Commodity prices may remain firm with the easing of COVID-19 related restrictions in some parts of the world. The ongoing pass-through of input costs, especially in services, could keep core inflation at elevated levels. Fiscal consolidation and stable INR however are some positive factors for contained inflation.

Inflation forecast: Assuming an average crude oil price (Indian basket) of US$ 95 per barrel (present price US$78.5/bbl) and a normal monsoon, CPI inflation is projected at 5.3% for 2023-24, well within the RBI tolerance band of 4 to 6%.

External balance comfortable

The current account deficit (CAD) for the first half of 2022-23 stood at 3.3 percent of GDP. The situation has shown improvement in Q3:2022-23 as imports moderated in the wake of lower commodity prices, resulting in narrowing of the merchandise trade deficit.

The net balance under services and remittances are expected to remain in large surplus, partly offsetting the trade deficit. The CAD is expected to moderate in H2:2022-23 and remain eminently manageable and within the parameters of viability. On the financing side, net foreign direct investment (FDI) flows remain strong; and forex reserves have recovered to 9.4 months of import. India’s external debt ratios are low by international standards

Remittances to remain strong on buoyant IT Service and growth in gulf region

Global software and IT services spending is expected to remain strong in 2023. Remittance growth for India in H1 of 2022-23 was around 26 per cent – more than twice the World Bank’s projection for the year. This is likely to remain robust owing to better growth prospects of the Gulf countries.

Growth forecast and policy stance incongruent

The real growth forecast of 6.4% by RBI is by far the most optimistic. Most agencies have been working with close to 6% growth estimates. The forecast of RBI appear even more unbelievable if we consider that —

(i)    The real rates are now mostly positive and close to the levels where these shall start hurting growth very soon. Given the current credit to deposit ratios for most of the banks, we shall soon witness the rates spiralling higher across the spectrum, further impacting the growth adversely.

(ii)   The tighter liquidity in the system has already started hurting the credit growth. A further withdrawal will definitely constrict growth going forward.

Obviously, something gotta give – either this high growth target would remain elusive or the MPC will have to climb down and change its policy stance.

Governor invokes Gandhi and Subhash

To mark the 75^th anniversary of nationalization of RBI, the governor invoked Gandhi and Bose.

“I do believe that…India…can make a lasting contribution to the peace and solid progress of the world.”  — Mahatma Gandhi

“…never lose your faith in the destiny of India” —Neta Ji Subhash Chandra Bose.

 The Reserve Bank of India (RBI) shall announce the latest monetary policy stance of its Monetary Policy Committee (MPC). While the market narrative is focusing on the decision regarding change in the policy rates, I believe the decision “to hike or not to hike” may not be the primary point of deliberations over the past two days.

In the past seven months since May 2022, RBI has hiked the key policy repo rate by 190bps. The benchmark bond yields or lending rates have not risen in tandem to the policy rates. Only the call money rates and bank deposit rates have seen a corresponding rise. This could mostly be a function of sharp rise in credit growth (now above 18%) at a time when RBI had reversed its accommodative stance and withdrawn over INR12trn of surplus liquidity from the market

The benchmark 10yr treasury yields have fallen 25bps in the past six months. However, 3-6months bond yields have seen sharp rise of 135bps and 112bps respectively.

 

The hike in repo rate has been only partly transmitted to the markets in terms of lending rates. The base rate of banks has risen from 7.25%-8.8% (in the week ending 06 May 2022) to 8.10% - 8.80% (in the week ending 02 December 2022). MCLR of banks has changed from 6.50% - 7.00% to 7.05% - 8.05% during this period. Savings bank rates (Nil change) and small savings rates have hardly moved in this period. However, the bank deposit rates have grown much faster from 5.00-5.6% to 6.1% - 7.25% during this period.

The call money rates have risen from an average of 3% to 5% during this period.

From the above it appears that it is the withdrawal of accommodation (liquidity) that may have impacted the money market rather

The monetary tightening in the past seven months does not appear to have material impact on the price level, which continues to remain elevated, led by energy and food. Of course, the monetary policy measures usually impact the prices with some time lag and we may see the prices correcting going forward.

However, what may worry MPC is that the growth is already showing signs of slowing. Negative real rates on deposits are hurting savings. There is not much evidence of rising rates destroying consumption so far, but we may see it going forward. The global commodities appear to have bottomed and a China reopening is seen as a trigger for rise in commodity prices, despite slowing global growth. The rising external vulnerabilities might keep USDINR under pressure, keeping imported inflation high. Obviously, MPC cannot ignore the actions of the Fed and the narrowing gap between India and US risk free yields.

Besides, MPC must have given a roadmap to the government to bring inflation within its tolerance band of 4-6% last month. The statement today might echo the commitments made in the letter written to the government last month.

So, MPC would have deliberated how to find equilibrium between liquidity, inflation, growth, external stability (Fx reserve, flows, USDINR, export competitiveness), financial stability and also political expediency.

 The minutes of the last meeting of the Federal Open Market Committee (FOMC) of the US Federal Reserve System (Fed), held in November 2022, were released a couple of days ago. The meeting was a joint meeting of the FOMC and the Board of Governors of the Fed, hence the number of participants were much larger than a usual FOMC meeting.

After the release of the minutes, the popular media narrative has been that the Fed officials and most participants are concerned about the likely adverse impact rate increases could have on financial stability and the economy; hence, we could “soon” see the Fed scaling down the pace of rate increases. The markets have obviously drawn a sense of comfort from this narrative and decided to move higher.

The minutes make some points that I found worth noting. From a plain reading of the minutes, I find that the participants were generally—

(a)   Surprised by the resilience of the job market;

(b)   Concerned about the persistence of the inflation and assessed the risk on the upside;

(c)    Comfortable with the broad economic conditions which are presently indicating slower growth but no risk of recession;

(d)   Comfortable with the anchored inflationary expectations;

(e)    Confident that the monetary tightening will reflect on inflation and other economic conditions with a time lag;

(f)    Inclined to keep the monetary policy “restrictive” for long;

(g)    Focused on the final Fed rate that would be adequately restrictive, rather than the rate hiked per meeting; and

(h)   Mindful of the market expectations and behaviour about the monetary policy direction and trajectory.

The media narrative of a slower pace of hikes (50bps in December meeting), seems to be driven by the following five mentions in the FOMC minutes:

1.    The minutes noted that “Most respondents to the Open Market Desk’s surveys viewed a 50 basis point increase in the target range for the federal funds rate at the December meeting as the most likely outcome.”

2.    “A number of participants observed that, as monetary policy approached a stance that was sufficiently restrictive to achieve the Committee’s goals, it would become appropriate to slow the pace of increase in the target range for the federal funds rate. In addition, a substantial majority of participants judged that a slowing in the pace of increase would likely soon be appropriate. A slower pace in these circumstances would better allow the Committee to assess progress toward its goals of maximum employment and price stability. The uncertain lags and magnitudes associated with the effects of monetary policy actions on economic activity and inflation were among the reasons cited regarding why such an assessment was important.”

3.    “A few participants commented that slowing the pace of increase could reduce the risk of instability in the financial system.”

4.    “Some participants observed that there had been an increase in the risk that the cumulative policy restraint would exceed what was required to bring inflation back to 2 percent. Several participants commented that continued rapid policy tightening increased the risk of instability or dislocations in the financial system.”

5.    “There was wide agreement that heightened uncertainty regarding the outlooks for both inflation and real activity underscored the importance of taking into account the cumulative tightening of monetary policy, the lags with which monetary policy affected economic activity and inflation, and economic and financial developments.”

Interestingly, the media narrative generally ignored the following noting, that indicate lack of consensus on slowing the pace of hikes:

A.    “A few other participants noted that, before slowing the pace of policy rate increases, it could be advantageous to wait until the stance of policy was more clearly in restrictive territory and there were more concrete signs that inflation pressures were receding significantly.”

B.    “With monetary policy approaching a sufficiently restrictive stance, participants emphasized that the level to which the Committee ultimately raised the target range for the federal funds rate, and the evolution of the policy stance thereafter, had become more important considerations for achieving the Committee’s goals than the pace of further increases in the target range. Participants agreed that communicating this distinction to the public was important in order to reinforce the Committee’s strong commitment to returning inflation to the 2 percent objective.”

C.    “Members agreed that, in assessing the appropriate stance of monetary policy, they would continue to monitor the implications of incoming information for the economic outlook. They would be prepared to adjust the stance of monetary policy as appropriate if risks emerged that could impede the attainment of the Committee’s goals. Members agreed that their assessments will take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments.”

D.    “Russia’s war against Ukraine is causing tremendous human and economic hardship. The war and related events are creating additional upward pressure on inflation and are weighing on global economic activity. The Committee is highly attentive to inflation risks.”

In my view, the chances are high that the Fed may slow the pace of hikes from the December meeting; but the end rate may be higher than previously estimated. We may have decisively shifted to “higher for longer” from “lower for longer” rate scenario.

More on FOMC minutes next week.