Vijay Kumar Gaba

 In my view, the stock market outlook in India, in the short term of one year, is a function of the following seven factors:

The first of the current financial year progressed on the predicted lines. There were no remarkable surprises either in the global macroeconomic developments or market performance. The focus of market participants and policymakers remained mostly on the macroeconomic parameters. Economic growth and trade moderated worldwide with a few exceptions like India. Inflation remained elevated but under control. Monetary policy continued to tighten resulting in higher bond yields, tighter liquidity, and rising cost of capital. Geopolitical conditions remained mostly unchanged.

Commodity prices moved in tandem with the macroeconomic, geopolitical, and environmental conditions. Clouded growth outlook led the industrial metals down; higher bond yields and stronger USD weighed the precious metals lower, depleted strategic reserves and larger output cut by OPEC+ led the energy prices higher, and better crop and improvement in shipments from war zones led the agri produce prices lower.

Chinese equities (especially in Hong Kong) performed the worst amongst peers; whereas Indian equities were amongst the best performing assets.

India did well on most parameters; domestic flows ex-SIP negative

The Indian economy grew ~8% in 1QFY24 and is expected to log an average growth of 7.25% in 1HFY24. The benchmark bond yields (10yr G-Sec) withstood the pressures of rising global yields and potential fiscal pressures due to rising crude prices amidst a heavy election schedule, and eased 5bps. Despite the cloudy CAD outlook, INR remained one of the strongest emerging market currencies. It weakened ~1% against USD, but recorded decent gains against EUR, JPY and GBP.

The consumer price inflation remained elevated, within the RBI tolerance band, primarily due to vegetable and fruit prices; whereas wholesale prices entered the deflation zone. RBI has maintained a status quo on the benchmark rates since the last 25bps hike in February 2023; and continued with the withdrawal of accommodation provided during the Covid period. At the end of 1HFY24, the banking system liquidity was in negative territory vs the peak surplus of Rs12trn during 2022.

Corporate earnings trajectory continued to improve, with NIFTY50 RoE breaching the 15% mark for the first time after 2015. The breadth of earning also improved with a larger number of companies and sectors participating.

The benchmark Nifty50 gained ~13% during 1HFY24. The broader markets however did extremely well with small cap (~42%), midcap (+35%), and Nifty 500 (+19%) registering strong gains. The gains were led by rate-sensitive sectors like Realty, Auto (especially ancillaries), and PSU Banks. Infrastructure, Capex and healthcare themes also outperformed the benchmark indices. Non-PSU financials and services were notable underperformers.

Within the capex and infra theme, defense production, power utilities & equipment, railways ancillaries, and engineering design services were the most notable gainers. Chemicals and consumer durables were some of the notable underperformers.

Foreign investors were net buyers in five out of six months during 1HFY24. Net FPI flows in the secondary market exceeded Rs1.24trn. Domestic institutions on the other hand were not as enthusiastic. The net domestic flows were a meager Rs141bn during 1HFY24. However, adjusted for the strong SIP flows (appx Rs140bn/month), the domestic flows have been strongly negative.

 The total foreign exchange reserves of India stood at a comfortable US$594.8bn; appx 16% of the estimated FY24 nominal GDP of US$3.6trn. To put this number in perspective, in the last twelve months, India’s trade deficit (Export-Imports) was US$229bn. For FY23, the total current account deficit was US$67.1 while net receipts of capital account were US$57.9bn.

Notably, the forex reserve position of India has not changed materially in the past five years. The forex reserves of India stood at US$422.53bn at the end of FY18, appx 16% of FY18 nominal GDP. The reserves peaked in September 2021 at US$642bn as Covid-19 induced lockdown resulted in the collapse of trade. The recent low was recorded in October 2022 (US$531bn). Since then the Reserve Bank of India has recouped over US$60bn of reserves, bringing the reserves to a comfortable position.

For records, the forex reserves broadly include foreign currency assets (89%), Gold (7%), Special Drawing Rights (3%), and reserve position in IMF (1%). The share of USD or US denominated assets in total forex reserve is usually 60 to 70%; similar to the composition trade invoicing of India. Hence, USDINR movement impacts the reserves materially. 

The forex reserve movement during FY23 has however highlighted a few red flags that need to be tracked closely, especially in view of the slowing global economy (cloudy export outlook), rising energy prices (rising import bill) and shrinking US-India yield differential (pressure on USDINR exchange rate).

·         FY23 The Current Account Deficit of India increased to US$67.1bn against US$38.8bn for FY22.

·         Net capital account receipts were lower at US$57.9bn vs US$86.3bn in FY22. Foreign Direct Investment (FDI) was lower at US#28bn vs US$38.6bn in FY22. Foreign portfolio investment remained negative (-US$5.2bn) after an outflow of US$16.8bn in FY22

·         External Commercial Borrowings were also negative (-US$8.6bn) against a net ECB inflow of US$8.1bn in FY22.

·         High cost NRI deposits (+US$9bn vs US$3.2bn in FY22) were notable contributors to the capital account.

·         INR exchange rate weakness contributed negatively to the overall reserve position for the second consecutive year.

A major global credit event may not put India in a crisis situation like 2008 or 2013. Nonetheless, a significant deterioration in the reserve position may put pressure on the INR exchange rate, credit spreads, and bond yields.

 One of the elementary principles of economics is that the price of anything is determined by the equilibrium of demand and supply. Though sometimes, in the short term, a state of inequilibrium may exist leading to higher volatility in prices; the equilibrium is usually restored by operation of a variety of factors. This principle usually applies to all things having an economic value, including currencies, gold and money (capital). The traits of human behavior like "greed", "fear", "complacence", "renunciation", and "aspirations" are usually accounted for as the balancing factors for demand and supply and not considered as determinants of price as such.

However, the case of currencies and capital is slightly complex given currency’s dual role as a medium of exchange and a store of value; and use of money as a policy tool to achieve the objectives of price stability, financial inclusion, poverty alleviation, social justice etc.

As a medium of exchange, price of currency is mostly a function of demand and supply of that currency at any given point in time. Higher supply should normally lead to lower exchange value and vice versa. The demand of the currency as medium of exchange is determined by the factors like relative real rate of return (interest), terms of trade (Trade Balance etc.), and inflation, etc. in the parent jurisdiction.

As a store of value, the price of a currency is, however, materially influenced by the faith of the receiver in the authority issuing such currency. For example, to the transacting parties, promise (since the currency is nothing but a promissory note) of the US Federal Reserve may hold much more value than the promise of, say, the Reserve Bank of Australia; regardless of the fact that the Australia runs a current account surplus, has lower interest rate, a similar inflation profile and a much stronger central bank balance sheet (as compared to the US Federal Reserve) and public debt profile. (1.50AUD=1USD)

Similarly, price of money (Interest rates) is usually a function of demand and supply of the money in the financial system. Demand for money is usually impacted by the factors like level of economic activity and outlook in the foreseeable future; whereas supply of money is mostly a function of risk perception; relative returns and policy objectives.

In Indian context, exchange value of INR, 10yr benchmark yield and crude oil prices evoke much interest. Interestingly most economic growth forecasts appear predicated on these, whereas logically it should be the other way round. Politically also, the USD-INR exchange rate is a popular rhetoric of the politicians on all sides of the Indian political spectrum. Recently, the rise in the international acceptability of INR has become a popular plank of the incumbent government; though there is little evidence of this happening as yet. The politicians refuse to acknowledge that INR depreciation is a normal economic phenomenon, and there is nothing at present that can reverse it.

To further emphasize my point, I may reiterate the following narration from one of my earlier posts.

“In the summer of 2007, I had just moved to the financial capital Mumbai from the political capital Delhi. The mood was as buoyant as it could be. Everyday plane loads of foreign investors and NRIs would alight at Mumbai airport with a bagful of Dollars. They would spend two hours in sweltering heat to reach the then CBD Nariman point (Worli Sea link was not there and BKC was still underdeveloped), and virtually stand in queue to get a deal where they can burn those greenbacks.

Mumbai properties were selling like hot cakes. NRIs from the Middle East, Europe and US were buying properties without even bothering to have a look at them. Bank were hiring jokers for USD 100 to 500k salary for doing nothing. I was of course one of these jokers!

That was the time, when sub-prime crisis has just started to grab headlines. Indian economic cycle started turning down in spring of 2007, with inflation raising its head. RBI had already started tightening. Bubble was already blown and waiting for the pin that would burst it.

INR had appreciated more than 10% vs. USD in the first six months of 2007. However, since January 2008 (INR39=1USD) INR has depreciated over 112% till now (INR82.6=1USD). In the meantime, the Fed has printed USD at an unprecedented rate; and there has been no shortage of supplies of EUR, GBP and JPY either.

The point I am making is that in the present times when the balance sheets of most globally relevant central bankers are running out of space to accommodate additional zeros and their governments are still running fiscal deficits are with impunity to service the mountains of their debts and profligate policies, the value of currency is definitely not a function of demand and supply alone. Regardless of economic theory, it is the faith of people in a particular currency that is the primary determinant of its relative exchange value.

2005-2007 was the time when the Indians had developed good faith in their currency, due to high economic growth. Local people were happy retaining their wealth in INR assets, despite liberal remittance regulations and NRIs were eager to convert a part of their USD holding in INR assets. The situation changed in 2010 onwards. There is no sign of reversal yet. Despite the huge popularity of the incumbent prime minister amongst overseas Indians, we have not seen any material change in remittance patterns in the past six years. Despite tighter regulations, local people appear keen to diversify their INR assets. Most of the USD inflows have come from "professional investors" who invest others' money to earn their salaries and bonuses. These flows are bound to chase the flavor of the day, not necessarily the best investment. Whereas the outflows are mostly personal, or by corporates with material promoters' stakes. Even FDI flows have reportedly slowed down in the past one year.

In my view, no amount of FII/FDI money can strengthen INR if Indians do not have faith in their own currency. Yield and inflation have become secondary considerations.

Recently, the Reserve Bank of India released the “Report of Inter Departmental Group on Internationalisation of INR”. The IDG recommended a pathway to be followed for inclusion of INR in IMF’s SDR basket in the “long run”. Tomorrow, I shall discuss the recommendations of IDG tomorrow, in light of my assumptions.

 The US administration has reportedly reached a deal with the Congress majority leader to enhance the debt ceiling on the treasury and mitigate yet another default threat. This, like all previous episodes of default threats and debt ceiling hikes, would inevitably result in more debt, insolent fiscal profligacy and further distortions in capital allocation and unsustainable asset price inflation. At the other end of the spectrum, it could shift a couple of ounces from the weight of global confidence in USD (and hence UST) towards the still nascent movement to de-dollarize global trade.

In this context, the following trends may be pertinent to note, especially for the equity investors.

Negative divergence in OECD debt and yield

The elementary principle of economics is that the price of anything is a function of demand and supply equilibrium. Higher demand pushes the equilibrium to a higher price point and vice versa. However, the bond markets in developed economies have been defying this principle for the past 25yrs. The debt of OECD countries rose sharply post the global financial crisis (GFC) in 2008-09; but the yield on government bonds fell till 2022, creating a negative divergence in bond supply and bond prices.

The situation has shown some signs of reversal in the past one year, but this may not last if the US Federal Reserve decides to begin easing rates sometime in the next 12months, while the latest debt ceiling deal results in a massive rise in bond supplies.

This trend is relevant for equity investors, since this could keep the cost of capital lower, affording much higher price earnings multiples to various businesses.

Deflationary pressures to persist

Post the GFC, the developed economies in particular have struggled with persistent deflationary pressures. Despite unprecedented new money printing and near zero (and negative) rates, major economies faced strong deflationary forces. Consequently, the prices of financial assets and real estate witnessed strong bull markets. The reported debt deal would result in further strengthening of deflationary forces which are structurally aided by the adverse demographic changes and changing consumption patterns.

Indian debt no longer lucrative to USD investors

The spread between US and India benchmark 10yr G-Sec yields (318bps) is presently at its lowest level, at least since the GFC. Given the hedging cost and just 2 notch above junk rating for India G-Sec, presently the Indian bonds may not be very attractive for the USD investors. Though there is not much empirical evidence available to substantiate this, there is a probability of rise in flows to Indian equity, which has been witnessing strong FPI selling for the past couple of years.

 The past 10yrs (2013-2022) have been a period of great uncertainty and turbulence for the global economy, financial system and markets which were considerably weakened by the global financial crisis in the preceding five years.

Supported by abundant liquidity and lower rates, the markets weathered Tapering 1.0; Brexit; Covid-19 pandemic; Sino-US tariff war; remarkable shift in weather patterns; handing over Afghanistan to Taliban; Russia-Ukraine war; out of control inflation; and burst of technology stock bubble rather well. The end of near zero rate regimes and monetary tightening in the past one year has however made the markets jittery.

The current generation of the market participants (investors, bankers, analysts, intermediaries, and policy makers etc.) who are in their 20s and 30s have never practically experienced persistently higher inflation and consistently rising interest rates. They might have read case studies of the 1970s and 1980s era; but that is usually not a good substitute for personal experience. No surprise that their response to the situation, in terms of strategy, has so far not been adequate.

Despite historically low rates and unprecedented liquidity, the economic growth has been dismal and returns on various asset classes are not commensurate with the risk involved. Emerging markets which are usually beneficiary of lower rates and easy liquidity conditions have struggled, in terms of growth, asset prices and price stability.

Commodities performance subdued

Commodities that are considered proxy to growth, e.g., copper and crude oil, have fared poorly over the past decade despite near zero rates and abundant liquidity. Nymex crude oil prices have yielded a negative 2.3% CAGR; while copper has growth at a CAGR of 2.5%.

During 2020 we saw a massive anomaly in crude markets when Crude Oil futures traded at a massive negative US$37/bbl price for a day. Similarly, the Russia-Ukraine war and subsequent NATO sanction on Russia, created massive uncertainty over availability of gas to major European countries, sending them on a gas hoarding spree. Natural gas prices rose over 100% within 6months of the beginning of war; only to correct 80% from the recent highs closer to 2020 Covid lows.

India has held well

In all this turbulence and mayhem Indian economy and markets have held up strong and steady. Though things have been challenging in the past six quarters; over the past decade Indian assets (Equities, INR gold, bonds and USDINR) have yielded decent returns, outperforming most emerging markets and developed market peers.

The benchmark Nifty50 yielded an 11.3% CAGR in local currency over the past 10yrs. Even in USD terms, it yielded a decent 7.7% CAGR, much better than Chinese, Japanese, and European equities. USDINR depreciated at a CAGR of 3.4% over the past decade, making it one of the most stable currencies amongst larger emerging economies.

Cryptoes emerging as popular asset class

Cryptocurrencies have emerged as a major asset class over the past one decade. The value of the top cryptocurrency, BITCOIN, has grown at a CAGR of ~75% over the past one decade. Of course, given the poor understanding, still lower acceptability and strong challenges from governments, central bankers and traditional bankers, the volatility in prices of cryptocurrencies has been extremely high. Of late we have seen gradual rise in acceptability of Bitcoins.

A number of unscrupulous and untested business models emerged in trading, custody, and/or otherwise transfer of cryptocurrencies; causing tremendous losses to the unaware and greedy investors. This may reduce over a period of time as acceptability and awareness about cryptocurrencies improves.

Trend may continue in medium term

Currently a number of developed economies are struggling with demographic challenges; massive monetary overhang; unsustainable public debt; geopolitical tensions, and leadership vacuum. On the other hand, the Indian economy is gaining strength on the back of a favorable demography; disciplined fiscal; exemplary monetary policy; a decade of massive investment in capacity building, especially in physical infrastructure and import substitution (also see Time for delivery is nearing). It is therefore likely that Indian assets may remain steady and offer decent returns over the next decade also.

 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.

 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.

Yesterday some media reports indicated that according to an internal assessment by the finance ministry “India balance of payment (BoP) is likely to slip into a $45-50 billion deficit in the current fiscal year.” (see here) This is obviously not good news for the INR exchange rate. Nonetheless, USDINR has rallied to its best level in almost two months, in the past two days.

It is pertinent to note that India’s current account has remained mostly negative since the global financial crisis (2008), with a brief period of surplus during Covid-19 pandemic. India’s current account deficit was $23.9 billion in the quarter ended June 2022, the worst since the last quarter of 2012. India had witnessed a serious current account crisis in 2013 that required the RBI and government to initiate some drastic measures like reducing limits under LRS. Of course, the present situation is not as dire as 2013, since we have a much stronger Fx reserve position now as compared to 2013. Nonetheless a close watch is warranted on the foreign flows, both portfolio and capital account. In the first nine months of the calendar year 2022, RBI has drained over US$100bn from the Fx reserves. The RBI has specified that this reduction in Fx reserve is due to two factors – (i) valuation adjustment (fall in value of non-INR denominated bonds and fall the relative value of Non-USD currencies in the Fx reserve); and (ii) intervention in Fx market to support INR exchange rate.

Various analysts have estimated that over 50% of drawdown in the reserves could be attributable to the valuation adjustment and the rest to the RBI’s forex market intervention.

As of this morning, there are little indications to suggest that this trend of fall in reserves, either due to valuation adjustment or market operations, may not continue for at least next 6-7 months; given the forecasts of a deeper recession in Europe (more fall in the value of EUR, GBP, CHF and European treasuries); persistent weakness in JPY; and slowdown in the US economy. Poor export growth and thinner FPI/FDI flows might keep India’s current account and Balance of payment under pressure.

The private sector capex is showing no sign of a significant pickup. Most of the capex so far seems related to maintenance, upgrades, debottlenecking etc. The outlook for exports is also not very encouraging.

The government has frontloaded capex, especially in roads, defense and railways. 2HFY23 might witness some slowdown in government capex as the fiscal position tightens (1HFY23 fiscal deficit has been higher due to front loaded capex despite buoyant tax collections).

Overall, we may have some strong macro headwinds for markets in 2023. Investors need to remain watchful and not get carried away by the recent recovery in benchmark indices.

 The monsoon this year is progressing well. At midpoint of the season, about 70% of 703 districts in the country have received normal to excess rains; and only 5% districts are witnessing a large deficiency. With the dark monsoon clouds hovering over most parts of the country, the skies in markets appear bright and sunny.

The stock markets and bonds have mostly recouped the losses made in the past four months. USDINR is also trading at two months low. Economic indicators are no longer worsening – inflation is high but stable; tax collections are strong; fiscal deficit is under control; core sector growth is recovering; bank credit to industry is picking up; leading indicators like vehicle sales (especially commercial vehicles), freight carried; port & railway traffic are all showing signs of stabilization and recovery. Current accounts are a cause of concern. However, positive FPI flows in July and recent correction in global crude oil prices are providing at least some comfort; which is reflected in INR appreciation also.

The market narratives have also changed remarkably in the past couple of weeks. The phrase “Hyperinflation” has almost vanished from the market discussions. Recession, Peak rates, Peak USD, Peak crude prices, wider adoption of Bitcoin, equity market bottom etc. are now increasingly finding mention in the market commentaries. For example—

CITI Global Commodities Research recently, inter alia, noted “Most analyses of oil markets emphasize the consequences on prices of further supply disruptions. In this report we focus on the potential consequences of an increasingly likely recession. In a recession scenario with rising unemployment, household and corporate bankruptcies, commodities would chase a falling cost curve as costs deflate and margins turn negative to drive supply curtailments.”. It further noted that “It looks as though for this year and into 2023 Russian crude oil exports may remain robust, even if refined product exports may fall. Therefore, further global oil demand weakness should spell higher inventories and weaken oil prices. Yet, the distortionary impacts of Europe boycotting increasing volumes of Russian oil should continue to be headwinds for global oil prices. In a recession scenario, we would see oil prices falling to $65/bbl by year end and potentially to $45/bbl by end-2023, absent intervention by OPEC+ and a decline in short-cycle oil investment.”

Jefferies, in the latest edition of its signature report Greed & Fear '' noted that “There is no doubt that financial markets, in the midst of the silly season, have been in an awful hurry to price in the peak of inflation and the end of Fed tightening. Fed tightening expectations peaked in mid-June at 4% in early 2023 while the money markets are now discounting 50bp of easing next year after the federal funds rate peaks at an assumed 3.25-3.5% in December, or 100bp above the current level following the 75bp hike yesterday to 2.25-2.5%”.

Lazard Asset Management believes that “Despite lingering headwinds, like fallout from regulatory crackdowns and zero-COVID policy aftershocks, China’s growth trajectory is still likely to show a recovery in the second half of 2022, and opportunities may be ripe for the picking in this vast market”. It also noted in a recent report that “Emerging markets fundamentals are in a relatively solid position overall especially as higher commodity prices have improved the terms of trade for commodity-exporting countries. As such, the current account and fiscal balances for many countries have improved while debt valuations have grown significantly more attractive’ – clearly a sign of preference for a “risk on” trade.

Bank of America Research in a recent report, estimated that the US 10yr benchmark bond yields could reach 2% in less than a year.

Particularly, in the Indian context, the market participants seem quite relaxed after the recent market run up and correction in crude oil prices. Recently released World Economic Outlook by the IMF mentioned the resilience of the Indian economy, expecting it to grow ~8% in 2022 and ~6.4% in 2023 despite a widespread global slowdown. As per Emkay Research, H2FY23 may reveal India’s ‘true’ growth trajectory, based on: a slew of reforms in recent years, improving EoDB, thrust on domestic mfg., rising capacity utilization; marginal base-effect from Omicron should be a bonus.” Though the brokerage firm finds food and energy inflation a key challenge for the Indian economy, it notes that the underlying drivers of globalized inflation are cooling, overall easing the inflationary pressures. It accordingly believes that margin pressures on the commodity consumers are beginning to ease and shall reflect in 2HFY23 numbers.

Brokerage firm Edelweiss believes that “US Recession Fears Overplayed - Recessionary models show a low probability of the US undergoing recession. After a dismal H1 of the year, H2 has a better probable payoff. The U.S & European Market are likely to consolidate in the later half of the year and likely to underperform other world equity markets. Emerging markets seem to have limited downside as compared to developed markets.”

There is an old legend. From time to time, numerous versions of this legend have been narrated by wise people to highlight the adverse effects of not admitting the mistakes early enough; indecision; and failure to assess the gravity of an adverse situation. One version of the legend goes like this—

Once a thief was caught stealing a sack of onions from a farmer’s house, and was produced before the magistrate. On asking, the thief first pleaded “not guilty”. After a trial the magistrate found him guilty of stealing and allowed him to choose his punishment from the following three options – (i) Pay five gold coins to the farmer; (ii) eat hundred onions from the sack he tried to steal; or (iii) get whiplashed hundred times.

The thief chose to eat the hundred onions, without giving it a thought, assuming it to be the easiest one. However, after eating just twenty five onions, he was in tears. His stomach started to burn and refused to take anymore. He begged the magistrate to change his punishment to a hundred whiplashes. The magistrate allowed his request and ordered his men to whiplash the thief a hundred times. After taking twenty five lashes his skin started to come off and pain started to become unbearable. He again implored the magistrate to stop his men and allow him to eat onions. The magistrate agreed to his request. He ate another twenty five onions and could see the grim reapers (Yumdoot) standing right in front of his eyes. He now pleaded to the magistrate to allow him to pay five gold coins. Had you stopped for a couple of minutes to think about the options presented to you, you would not have suffered so much the magistrate chided him, agreeing to his request.

The moral of the story is that if the thief had admitted his mistake early, the magistrate could have let him off with a milder sentence. He chose a sentence which he had no clue about, rather than opting for the clearly defined monetary fine. Also, despite suffering once, he still did not opt for the right option and suffered an avoidable twenty five lashes and twenty five more onions.

The situation of the Reserve Bank of India (RBI) is somewhat similar to the thief in the legend. It refuses to admit that it has been confused between growth and inflation for long. It also refuses to accept that in the present situation the factors driving the inflation are mostly beyond its control; and it can only manage a small part of the inflation by hurting the growth significantly and imperiling the financial stability!

Palpably, the out of turn rate hike by RBI is aimed to protect the INR. The fear of the larger outflows, as other central bankers hike rates aggressively, appears to have prompted the RBI to make a preemptive hike. The currency market though does not appear impressed by the RBI move, and INR has weakened to its lowest level ever. The outflows have continued in the equity as well as debt market, despite higher yields (bonds) and lower valuations (equity). The RBI might thus have wasted one important arrow (40bps rate hike) in its quiver.

The situation is vividly reminiscent of the current account crisis of 2012-2013. The INR witnessed violent volatility and outflows were strong in light of taper tantrums. The rate hikes at that time did not help much and we were very close to a balance of payment crisis. The RBI changed its approach in September 2014 and an imminent disaster was averted, but not without some serious damage to the financial stability and growth ecosystem.

I assume this time we will not be driven to the brink like 2013, and the crisis will be mitigated soon. For now we are eating onions only. I hope the economy will be spared whiplash and gold coins.