Vijay Kumar Gaba

 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.

It’s almost a year since the Reserve Bank of India shifted the course of its monetary policy stance and embarked on the path of monetary tightening and withdrawal of accommodation to reign in runaway inflation. In the course of its journey in the past one year, RBI reversed the entire 250bps of rate cuts made during 2019-2020. 

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.

 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.

In the past one year, inflation has been one of the primary concerns for most countries across the globe. Rising prices of food and energy in particular have materially impacted the lives of common people on all continents. The central bankers of most major economies have hiked policy rates in the past one year to control inflation. In the current year 2023 so far, 13 major central bankers have taken policy action(s) and all of these actions have been hike in policy rates.

However, in recent weeks inflation has shown some tendency of cooling down. It is difficult to assess how much of this cooling down is due to tighter monetary conditions; and how much could be attributed to other factors like restoration of supply chains that were broken during the pandemic and warmer winters resulting in lower energy demand in the northern hemisphere, etc. Nonetheless, some central bankers have adjusted the pace of tightening to smaller hikes. Most of them, though remain circumspect about the persistence of inflation. While the debate continues over the trajectory of price hikes in the next few quarters; an overwhelming majority of experts believe that prices may remain high for much longer.

The global growth forecasts have witnessed some downgrades in the past six months as tighter monetary conditions and higher prices are seen hurting demand for consumption and investment. As per the latest assessment of the World Bank, in 2023 “the world economy is set to grow at the third weakest pace in nearly three decades, overshadowed only by the recessions caused by the pandemic and the global financial crisis….Major economies are undergoing a period of pronounced weakness, and the resulting spill-overs are exacerbating other headwinds faced by emerging market and developing economies (EMDEs).” 

With this background, three key issues that could influence the future trajectory of global prices and therefore interest rates are geopolitical situation; impact of China ending Covid restrictions and the impact of the emergence of El Nino on global food production.

Geopolitical conflict in Eastern Europe (Russia-Ukraine) has materially influenced the prices of energy and food in the past one year. Any worsening or this conflict or expansion to Western Europe could make things worse. Some events in the recent weeks have indicated that Sino-US relations may not improve anytime soon. NATO countries hardening their stand on Russia; Russia retaliating with a cut in energy output; and some key OPEC members openly expressing disagreements with US oil pricing has materially increased the uncertainty in the energy market.

China has been gradually relaxing the covid restrictions for the past many months. This has eased the logistic logjam across the world. The supply chains that were broken due to congestion at major ports, shortage of containers, short supply of key raw materials, and poor take-off have mostly been repaired. The freight rates that had become prohibitively high have eased to pre Covid (2019) levels. The debatable question however is whether China reopening will be inflationary (higher demand) or deflationary (complete supply chain restoration and consequent destocking; improved mobility of workers etc.).

As per the latest forecast of various weather agencies (see here), the probability of El Nino conditions developing in the coming summer could impact the agriculture production in major countries like India, this year. If these forecasts come true, we may see food prices remaining at elevated levels.

A variety of views prevail on these three issues and their outcome. In my view, China reopening will indubitably be deflationary for the global economy, especially metals and other raw materials).

I am however not sure about the geopolitical conditions. I would therefore continue to expect elevated crude oil prices through 2023. By the way, the RBI in its latest statement has assumed the price of Indian basket of crude oil to be US$90/bbl for FY24, against the current price of US$84.19/bbl (see here).

It is little early to talk about weather conditions in the forthcoming summer and its eventual impact on global food prices. For now, the Rabi crop in India appears to be good; and there is enough food in the Indian granaries. Thus availability of food should not be a problem for sure even if we had a poor monsoon year after three normal/excess monsoons.

 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 Financial Stability Report released by the RBI a few weeks ago, highlights the external sector challenges being currently faced by the Indian economy. The report however seeks to dispel the fears of any balance of payment crisis like 2013. It also assures about the adequacy of reserves to handle the present situation and stability of the INR.

External sector facing challenges

India’s merchandise trade deficit increased to a staggering US$198.3bn during April-November 2022, as compared to US$115.4bn in the corresponding previous period. Strong headwinds emanating from still elevated commodity prices, global economic slowdown, volatile capital flows and higher imports due to adverse terms of trade shock continue to exert pressure on India’s external account. 

Rising oil import bill limits policy flexibility; CAD rises sharply

India’s share in global crude oil consumption increased from 3% in 2000 to 5.2% in 2021. India presently accounts for almost 20% of each barrel of incremental global crude demand. Weakness in USDINR is further amplifying the pressure on imports.

Given the structural dependence on the imported crude oil, India continues to remain a price taker in the global oil market. This limits the scope of policy manoeuvrability in managing the trade deficit. Consequently, the current account deficit has widened to a worrisome 4.4% of GDP in 2DFY23 (2.2% in 1QFY23 2.2% and 1.2% in FY22).

Net capital flows were inadequate to fund the current account deficit, resulting in depletion of forex reserves to the extent of US$30.4bn in 2QFY23. The flows improved in 3QFY23, resulting in improvement in forex reserves.

Repayments of ECBs (rise in refinancing cost, withdrawal of liquidity in global markets, improvement in domestic corporate balance sheets) also contributed negatively to the balance of payment.

External debt situation comfortable

India had an external debt of US$610.5bn at the end of 1HFY23. The short term debt (residual maturity less than one year) comprised 45% of this debt. 55.5% of the external debt was USD denominated at the end of September 2022 (53.2% at the end of FY22); while 30.2% debt is INR denominated.

As of September 2022, about US$173bn worth of ECBS were outstanding with an average maturity of 5.6yrs. About 81% of all ECBs are USD denominated.

Out of this about 50% (US$87.6bn) were the USD loans owed by the Indian private enterprises; the rest being outstanding of subsidiaries of foreign parents (US$28.5bn); INR denominated ECBs (US$15.1bn); ECB by PSUs (US$53.2bn). Out of US$87.6bn Non INR, Non FDI ECBs, about 55% is hedged while most of the balance has a natural hedge against receivables.

Given the current Forex reserve of over US$565bn, the external payment default risk is negligible; and so is the collapse risk for INR.