Do it yourself: USDINR

Showing posts with label USDINR. Show all posts

Tuesday, December 10, 2024

Do we need to worry about the external situation?

Notwithstanding a marked slowdown in the past few quarters, the Indian economy has managed to grow at a decent pace in the current global context. Though India may have lost the crown of the fastest growing global economy to Vietnam, it still remains the fastest growing amongst the top 10 global economies.

The Reserve Bank of India is holding US$658bn in forex reserves, which is considered adequate in normal circumstances or even in a usual cyclical slowdown. Despite accelerated selling in equity markets by the foreign portfolio investors (FPIs), the current account deficit of ~1.5% of GDP, is conveniently manageable. INR has been one of the most stable emerging market currencies. On the real effective exchange rate (REER) basis INR is presently ruling at a five-year high level.

In their recent policy review, the Monetary Policy Committee (MPC) of the Reserve Bank of India has cut growth estimates for FY25 by 60bps to 6.6% and 1QFY26 by 40bps to 6.9%. The MPC has also hiked their inflation forecast for 2HFY25 and 1QFY26. The RBI estimates are still few basis points higher than the average estimates of professional forecasters, as per the RBI’s recent survey. It is therefore likely that growth slowdown extends well into 1HFY26.

RBI has once again made it clear that it is not comfortable about the inflation trajectory and would prefer to outweigh price stability against growth in its policy dynamics. In the recent meeting, the two external members of the MPC voted in favor of a 25bps repo rate cut, but the RBI’s official nominees voted to maintain a status quo, despite loud growth concerns and political rhetoric for monetary easing.

The market consensus seems overwhelmingly in favor of a February 2025 repo rate cut. This assumes growth staying in the slow lane; lower food and energy inflation; and fiscal improvement as promised in the union budget for FY25. We need to watch for development of La Nina, adversely impacting the Rabi crop; slowdown in tax collection and rise in cash subsidies due to election promises adversely impacting the fiscal disincline. Compensating higher subsidies with a cut in capital expenditure (as has been the case in 1HFY25) would further slowdown the potential growth, making any monetary easing more inflationary.

At the surface level there is nothing that would ring alarm bells for domestic investors. However, some of the recent actions of the RBI are reminiscent of the 2013 crisis period. The monetary policy is increasingly sounding like a plan to secure the stability of USDINR.

I wonder if RBI is really worried or it is just cautious and taking preemptive steps to mitigate any chance of a balance of payment crisis and/or currency volatility.

I have taken note of the following data points; and at the risk of being labeled unnecessarily paranoid, I would keep a close watch on these for the next few months to assess any vulnerability in India’s external sector.

· There has been a marked slowdown in foreign flows -both portfolio flow and FDI flows in the past one year. The political changes in the US and Europe may further impact the flows in 2025. RBI may not want to further discourage flows by offering lower bond yields. For record, the India10y-US10y yield spread has already fallen from a high of 350bps in January 2024 to ~250bps.

· RBI has created a record short position in USD (over US$49bn in forward market) in the past couple of months to protect USDINR; besides running down Fx reserves by ~US$47bn in just one month (from US$705bn in October 2024 to US$658bn in November 2024)). It has taken almost US$96bn to keep USDINR stable in the 83-50-84.50 range.

It is critical to watch this because:

The global trade war could escalate, before it settles after the inauguration of President Trump. This could slowdown global trade; lead to China dumping on non-US trade partners; slowdown in remittances and services exports to some extent.

As the denominator (nominal GDP) goes down and exports also slow down, the current account deficit may show a tendency to rise, pressuring INR. The RBI cannot afford to spend another US$100bn on defending USDINR.

RBI has hiked the ceiling on interest rates offered by scheduled commercial banks on foreign currency deposits of NRIs. This is an early sign of the RBI worrying about Fx reserves. Any measure to limit foreign spending, investments (outward FDI) and LRS remittances will confirm these fears.

Presently, FPIs own about US$650bn worth of Indian equities, which is equal to official fx reserves of India. A US$12bn (appx 1.75% of total holding) sale in the past couple of months has caused some damage to the market sentiments. A 5% selling (US$35bn) could seriously damage equity markets, currency markets and RBI’s gameplan. Remember, on an average, we are running a ~US$20bn/month trade deficit; and a net external debt of over US$682bn. In a crisis situation, US$658bn reserves might not prove to be adequate.

· President-Elect Trump and some of his designated team members have explicitly termed India a “currency manipulator” and demanded RBI to strengthen USDINR. If RBI is forced to meet these demands, it may need to unwind its short USD position, conduct aggressive OMO to buy USD from the market, and engineer higher yields (bond and/or deposits) to attract more USD flows into India. This could make maintaining current account balance a challenging task. Especially in an environment, where China could be dumping everything in the global markets, and competitors like Vietnam, Indonesia, Philippines, Turkey are becoming very aggressive.

If you find it confusing, impertinent, misplaced, let me sum this up in short for you. I would prefer to totally avoid macro trades in 2025, and stay committed to individual business stories that I like.

Wednesday, December 4, 2024

To cut or not to cut

The 3-day bi-monthly meeting of the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) begins today. This would be the last meeting before presentation of the Union Budget for the year FY26. The members of the MPC would draw inputs from the latest national accounts (2QFY25 GDP data); October 2024 inflation data; October 2024 Professional managers’ survey results; September 2024 IIP estimates; November 2024 PMI and core sector growth data; April-October fiscal balance data; global developments (political and geopolitical); global inflation, rates, currency and market trends; expert opinions and views of the members of MPC; and assessment of the current and future situation provided by the staff of RBI.

The statement of the MPC on macroeconomic outlook and likely direction of the monetary policy will be a key input in preparation of the Union Budget for FY26. However, the market participants’ interest in the MPC meeting appears limited to whether, or not, at 10AM on 6^th December 2024, the RBI governor announces a repo rate cut and/or a cut in the cash reserve ratio (CRR). Some TV show panelists might also bother to note the downward revision, if any, in the growth estimates for FY25.

If the MPC decides to maintain a status quo on its policy stance – considering growth slowdown a temporary blip expecting a recovery from 3QFY25; and continue to accord higher weightage to still elevated inflation and highly uncertain and volatile global conditions, the market participants may be hugely disappointed.

Not to cut: In the October policy statement, the governor had adequately hinted about its preference for price stability over growth (see here). Perhaps RBI is much more conscious about the looming external threats, especially the balance of payment situation if there are sudden FPI outflows; or the FDI flows get restricted; or remittances are affected.

Or to cut: In the recent weeks, RBI has allowed USDINR to sustainably breach 84 mark. It appears that it may want USDINR to weaken further before Trump takes over the US presidency on 20^th January, and urges its trade-surplus trade partners to strengthen their currencies. We have seen a similar weakness in USDCNY also, for example. A token 25bps or an aggressive 50bps rate cut could drive USDINR to 86 in near term, providing RBI a leverage to engineer a ~5% USDINR appreciation to ~83 level in the next three months.

In either case, the transmission of the lower rates may not be in the corresponding measure, as RBI might continue to control credit growth and liquidity to reign inflation, asset quality and excessive unsecured lending. I therefore would not expect a CRR cut. I am however mindful that the market is pregnant with the hope of a CRR and/or repo rate cut and no action in this regard may lead to a sharp sell-off in financial stocks, especially NBFCs.

The market participants may also take note of the following three potential near term risks:

· Besides the real GDP growth, the nominal GDP growth has also fallen to 9% in the 2QFY25. A lower nominal GDP growth directly impacts the tax collections and corporate profitability. November manufacturing PMI is at 11 months low. Core sector growth has also been low in 3QFY25. Expecting an immediate revival of growth in 3QFY25 may not be prudent; and the RBI may not mind a transitory higher inflation to boost nominal GDP growth.

· The president-elect Trump has explicitly threatened the BRICS nations to refrain from any misadventure that would impact supremacy of USD. It may purely be rhetorical to gain some upper-hand in trade/sanctions negotiation with Xi and Putin. Nonetheless, it could cause higher volatility in the global markets. It becomes critical given that BRICS members supply two thirds of global fossil fuels.

· The outgoing president Biden has provided a complete pardon to his son, who was facing multiple criminal charges in the US. Biden had earlier categorically denied this favor to his son. Experts are interpreting this as an indication of rising fear of a widespread witch hunt by the Trump administration. The witch-hunt, if it does take place, may not remain restricted to the domestic political opponents of Trump.

Tuesday, October 22, 2024

Focus on finding opportunities

I shared some of my random thoughts with the readers last week (see here). Many readers have commented on my post. Some readers have raised some pertinent questions and also provided very useful feedback. Based on the readers’ comments, questions and feedback, I would like to share some more random thoughts. It is however important to note that I am a tiny insect living in a cocoon of my own. I cannot comment intelligently on the international markets, policy matters and geopolitics. Nonetheless, I reserve my rights to form strong views on global and domestic developments concerning markets, policies and geopolitics, for my personal strategy purposes.

The US debt end game

The current state of the Fed balance sheet and the US public debt is certainly not sustainable by any parameter. It is a matter of debate how the US government and the Federal Reserve would make fiscal and monetary corrections and eventually return to an acceptable level of public debt without pushing the economy into a deep recession (hard landing). One of the most talked about resolutions to this conundrum is to keep bond prices lower and buy back aggressively over the next few years. That may be one of the easiest ways to return to fiscal sanity. Creating an artificial shortage of USD and forcing UST holders to sell cheap could be one of the means to achieve this target. To create USD shortage, a reverse carry trade might be induced, by narrowing the yield spreads, besides reducing CAD through tariffs and other trade restrictions.

For context, the US is running a quarterly current account deficit in excess of US$260bn; a fiscal deficit of over US$1.7trn (2023) and USD supply (M2) of over US$21trn. The US GDP was US$27.4trn in 2023, accounting for roughly 26% of the global GDP.

The great gambler

The RBI governor's job in India might be the most unenviable one. He has to struggle 24X7 to maintain a balance between fiscal requirements, political consideration (inflation and small saving interest), growth needs (real rates) and balance of payment (USDINR exchange rates). Repo rate and open market operations are the only two major tools available to him.

The RBI has been maintaining a status quo on the repo rates for over a year now. This has sustained the US-India yield gap (to protect flows) to some extent, but the efficacy of high repo rates in ensuring price stability, which is the stated primary objective of the RBI’s monetary policy, is questionable. Besides, the RBI has been meaningfully enlarging its balance sheet in the post Urjit Patel era, while stated policy objective, until the last week, has been “withdrawal of accommodation”. This aspect is not talked about much in the public domain. One may speculate that the real objective of the RBI’s monetary policy has been to prevent USDINR appreciation (even if it means high imported inflation) and ensure sufficient inflow in small saving schemes, which are funding almost 45% of the union government’s fiscal deficit. It has been obviously playing a gamble with high stakes, US$700bn forex reserve notwithstanding.

Indian lenders face challenges

The persistent negative credit deposit ratio of Indian banks has been a subject of discussion at all levels. The government, regulators (RBI and SEBI), bankers and analysts etc. have all expressed concern over the poor deposit growth, while the credit demand remains strong. The finance minister and RBI have even attributed the flow of funds towards capital markets as one of the reasons. In my view, high household inflation, poor real wage growth and very low real rates on deposits are the primary reasons for this trend. Besides, for most lenders the asset quality improvement trend that started five years ago may have already peaked.

I feel most Indian lenders may now face three challenges – declining margins as the cost of funds rises; flat to declining asset quality and slowing growth. Investors are cognizant about these challenges but as the response to a recent IPO of a housing finance company indicates, they may not have yet adjusted their respective investment strategies.

Focus on finding opportunities

As a wise man suggested, the small investors like me should not be wasting energy on bothering about these macro things and focus on finding the investment/trading opportunities which may be opened by policy missteps, fund flows, geopolitical tensions etc. I fully agree with this thought. For the next 4-5 months, I shall be focusing on finding opportunities and taking advantage of traders’ mistakes.

Wednesday, October 16, 2024

Some random thoughts

Myth of free market

A fundamental principle of economics is that “in a ‘free market’ current price of anything having an economic value is a function of demand and supply of such things at that particular point in time.” Of course, there could be multiple factors that may impact the demand and supply of a thing; but usually nothing impacts the “price” directly other than the forces of demand and supply.

In a ‘controlled and/or manipulated market’ the prices of things are fixed by the controlling authorities (or forces); regardless of the demand and supply for such things. In such markets, usually demand and supply of things are controlled and/or manipulated; or demand and supply duly get adjusted to the fixed/manipulated prices.

In the modern world, money is arguably the largest factor of production in the world. The price of money (interest rate) should ideally be a function of demand and supply of money. In case of excess supply, the interest rates should be lower and vice versa.

If we apply this core principle of economics to the world around us, we may discover that a significantly large part of global markets is presently either controlled or manipulated. The free market may only be prevalent in textbooks now. It has been completely obliterated from the political speeches across the world; and is also being systematically removed from the policy documents.

The US Federal Reserve can simply manipulate the supply of the USD to influence the prices of bonds, goods & services denominated and settled in USD. An axis led by China and Russia is emerging to weaken the powers of the US to manipulate the global markets through controlling supply of USD. So far, it is more of an intention. There is no work-in-progress evident on the ground.

Removing all doubts

Notwithstanding all the grandstanding, global preaching, and progressive narratives, the US has mostly been a racist and sexist society. For many decades there was a pretense on part of the US politicians to present it as an inclusive, liberal and free society. In the ongoing elections the pretense has been shed. There is a conspicuous effort to make the contest between a Right wing, “white” supremacist “man” and a “woman who happens to be “black”.

Confidence of RBI

In its latest monetary policy report, the RBI has expressed strong confidence in the Indian economy. It projected the real GDP growth of 7.2% for FY25. It also sees the growth momentum sustaining in FY26 with 1QFY26 of 7.3%.

On the other hand, the brokerages are projecting material slowdown in profitability growth. The corporate tax collections for FY25, so far, are down 6% yoy. The core sector growth has collapsed to many months low in August. The capital expenditure of the states in FY25 is projected to be less than even FY23. The central government spending which has supported the growth since FY21 is also tapering. Private capex has picked up but is mostly related to asset (land and building) acquisition rather than enhancing productive capabilities.

I wonder where the confidence of the RBI is flowing from! Is RBI relying too much on the forward looking surveys indicating better business and consumer confidence for the future despite conspicuous deterioration in the current conditions? Or is there something not known to the markets; just like Haryana election results where CM Saini could clearly see what no one else saw.

INR, yields and rate cuts

RBI has apparently let go of the USDINR 84 level, which it was allegedly defending for almost a year. The FPI outflows are accelerating every week. The US0 India yield gap is narrowing, further raising the specter of accelerated outflows.

The benchmark US yields (now 4.10% rising 40bps after aggressive 50bps rate cut by the US Fed) and mortgage rate (now over 8%) have not behaved on the expected lines.

In India also there is almost a consensus over a repo rate cut in December. The MPC members might however be wondering whether it is desirable to waste one important arrow in their quiver at this point in time when there are ample indications of a crisis like situation emerging in 2025, requiring aggressive policy support. Given the market condition, a rate cut may not be passed on the borrowers as banks are already struggling with credit-deposit growth mismatch. The benchmark yields have already eased in anticipation of a cut and may not ease much post the cut. In any case, the RBI may not like the US-India yield spreads to narrow further, further pressurizing USDINR.

Tuesday, July 9, 2024

1H2024 – Buoyancy all around

The first half of the year 2024 has been good for global markets. Despite disappointment on rate cuts, geopolitical concerns, sticky inflation, and political changes in many countries, stocks, precious metals, industrial commodities and crypto made a steady move up with very relatively low volatility.

A notable feature of the global market movement in 1H2024 was the stark underperformance of Asia ex Japan, even though the Japanese equities being the best equity markets amongst the major global markets. Brazil also underperformed despite a decent rally in commodities.

Another notable feature of global markets was the narrow market breadth of US markets. Though the benchmark indices scaled new highs, it was mostly due to parabolic rise in a handful of technology stocks.

At present equity markets appear strong on the back of a resilient demand environment, well anchored inflationary expectations and peak interest rates. Fears of earnings failing to match the stock price rise, escalation in geopolitical tensions, spike in energy prices, uncertainties about the policy direction post the US presidential elections, and erratic weather conditions are some points of concern.

India performance – 1H2024

Indian markets performed very well in the first half of the year 2024. Though Indian equities underperformed the developed markets in line with the global trend, it did very well within the emerging market universe. The key highlights of the India market performance could be listed as follows:

· The benchmark Nifty50 gained ~10.5% during 1H2024; while the Midcap (+20.7%) and Small Cap (+21%) did much better. Consequently, overall market breadth has been strong.

· Two third of the market gains came in the month of June 2024, post the elections. This was contrary to the pre-election consensus that BJP failing to secure a majority on its own may result in sharp decline in market.

· The total market capitalization of NSE is higher by ~21%; more than gains in the benchmark indices – implying that stronger gains have occurred in the section of the market beyond indices.

· The number sector outperforming the benchmark indices far outnumbers the sector underperforming. The rally was led by Realty, PSUs (mostly power, defense, and railway), Auto, infra and energy. The Capital Goods and Heavy Engineering sector have been the flavor for the period. Particularly, the businesses catering to sectors like defense, railways, and road construction did extremely well. Banks, IT Services and FMCG were notable underperformers.

· Ship builders were the notable outperformers amongst the individual stocks. No conspicuous sectoral trend was seen for the losers.

· Institutional flows to the secondary equity markets were positive for five out of the six months. 1H2024 witnessed a total flow of ~INR3559bn, despite FPIs outflows of Rs320bn. The correlation of institutional flows with Nifty returns remained poor (~48%).

· The rates, currency and yields were stable in 1H2024. Policy rates were unchanged; while money market rates were marginally higher by 15bps. Deposit rates did not see much change while lending rates were higher by 10-15bps.

· The overall Indian yield curve shifted lower and flattened completely, as the RBI maintained the status quo on policy stance.

· The economic growth surprised on the higher side with the Indian economy recording a growth of 8.2% for FY24, beating all forecasts materially. Fiscal balance also improved with FY24RE fiscal deficit coming at 5.8% and FY25BE of fiscal deficit at 5.1%.

· CPI inflation has inched closer to the lower bound of the RBI’s tolerance band of 4%-6% with May’24 CPI inflation number coming at 4.75%.

Corporate performance has shown resilience in recent quarters, with sales growth recovering, margins improving and RoE rising. Banks reported consistent improvement in the asset quality and profitability.

Tuesday, May 14, 2024

What if?

Polling for the fourth phase of the 18^th general elections ended yesterday. Electorate from 380 Lok Sabha constituencies have exercised franchise to elect their national representatives. Over the next three weeks, eight states (full or partial), NCT of Delhi, and four union territories will vote in three phases. With 70% voting already over, a fair estimate of the national trends could be made by the experts.

Since the Election Commission of India (ECI) does not permit the publication or communication of the results in any other form of Exit Polls conducted by various agencies until the completion of voting for all seats, we do not have any expert opinion available about the likely outcome of the ongoing elections. However, a variety of guesstimates are available on social media and other platforms. Most of these guesstimates are speculative. These are either based on a small and localized sample; or gambling trends.

Many stock market experts have also presented their scenario analysis for the market performance depending upon the outcome of the general elections. Most experts have projected a sharp correction in the markets in case the incumbent BJP and its allies fail to secure the requisite majority in the Lok Sabha. As a keen political observer and a tiny investor, I am interested in these forecasts.

Unfortunately, I find that the discussions available in the public domain are not based on available empirical evidence; they lack credible analysis, and are highly speculative. These discussions deeply suffer from personal biases, political prejudices, and misplaced presumptions. One of the illustrative scenario analyses available in the public domain is reproduced below. In my view, nothing could be more baseless and more speculative than this analysis.

In the outgoing 17^th Lok Sabha, the incumbent BJP has 303 members, a strong majority. In the preceding 16^th Lok Sabha, the BJP had 281 members with its NDA allies having another 71 seats.

The preceding UPA government was arguably much weaker with no single party having a majority of its own. Regardless, the performance of USDINR and Nifty was better during 2004-2014 compared to the 2014-2024 period.

· Sensex yielded a return of 15.5% CAGR during the UPA regime (2004-2014), while the Sensex return has been ~12.2% CAGR during the NDA regime (2014-2024).

· USDINR had weakened at a pace of 2.7% CAGR during 2004-2014; while it has weakened at a pace of 3.5% CAGR during 2014-2024.

On the social and economic reforms front also there is no empirical evidence of weaker governments doing worse than the stronger governments in the past four decades.

In my view, the market does witness heightened volatility during general elections, but there is no empirical evidence to establish a direct correlation between market performance and the form and constitution of the ruling political dispensation in India.

…to continue tomorrow

Thursday, December 28, 2023

2024: Market Outlook and Strategy

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

Macroeconomic environment
Global markets and flows
Technical positioning
Corporate earnings and valuations
Return profile and prospects for alternative assets like gold, real estate, fixed income etc.
Greed and fear equilibrium
Perception of the political establishment

The outlook for these seven factors for the next twelve months is as follows, in my view—

Macroeconomic environment – Neutral

My outlook for the likely macroeconomic environment in 2024 is as follows:

(a) Inflation: Consumer inflation may average well within the RBI tolerance band of 4% to 6%. However, food inflation may continue to be erratic and cause occasional violations of the upper range.

(b) Fiscal Deficit: The fiscal situation of the central government may remain comfortable as the tax collections remain steady and revenue expenditure is controlled further. I do not expect any significant deterioration in fiscal conditions due to elections scheduled in 2024. No major tax/duty concessions are expected. Any major improvement in fiscal balance would depend on acceleration in asset monetization. The outcome of the general election will be a key factor in this regard.

(c) Rates: Expect benchmark yields to average in the 7.00% +/- 30bps range. The RBI may remain on pause in the first half and may deliver a 35-50bps cut in the second half depending upon the monsoon and global trend. No major change may be seen in deposit and lending rates as the liquidity remains tight and credit demand remains elevated.

(d) Current Account: Expect the current account balance to stay negative for most part of the year as import growth continues to outpace exports. The deficit may average around 1.5% to 1.75% for2024.

(e) Savings: Household savings may grow at an even slower pace as real wage growth remains poor. Aggregate corporate savings may also decline as capacity utilization increases and corporates embark on capex plans.

(f) Investment: The government investment expenditure may slow down in 1H2024 due to fiscal constraints and election-related restrictions. Private capex may maintain its 2H2023 trajectory. Overall, investment growth may see decent growth in 2024.

(g) Exchange Rate: USDINR may average close to INR83.5 +/- 1 range on a negative current account and elevated inflation.

(h) Growth: The real GDP growth for FY25 may average around 6.25% +/- 50bps despite a slower global economy. Strengthening of El Nino and a poor monsoon could impact the growth negatively by 50-60bps.

Overall, the macroeconomic outlook is neutral.

Global markets and flows - Neutral

Markets: The global analysts and economists are nearly unanimous on the growth recession in 2024. Most markets are currently pricing sharp rate cuts and monetary easing to mitigate the impact of economic slowdown. Any disappointment on this count may impact global markets adversely.

Flows: The outlook for USD is now negative as Fed is expected to deliver aggressive rate cuts. Flows towards emerging markets may accelerate in 2024 as cheaper money in developed market begins to chase yield again.

Technical Positioning - Negative

In my view, the benchmark indices are poised for a decent technical correction. and offer a negative risk-reward at the current level. A correction of 8-10% would make the market attractive again.

Technically speaking, Nifty may move in a wider range of 17390-23063 in 2024, averaging above 18880. Buying below 19400 will carry a positive risk reward.

Corporate earnings and valuations - Neutral

The earnings momentum may slow marginally as banks, energy and metal earnings growth peaks in FY25. No major acceleration in earnings is expected from FMCG companies. Power, IT Services, and Pharma are the notable sectors that are expected to delta in earnings. Overall, expect a 15% earnings growth, which may be lower than the current consensus expectation.

The visibility of the improved margins sustaining is decent. Higher capacity utilization may warrant capex, hence the beginning of a re-leveraging cycle from FY25. RoE therefore may not improve materially in next couple of years.

The present forward valuations are marginally higher than the long-term averages based on still marginally optimistic earnings forecasts.

Alternative return profile - Neutral

Real estate: Real estate prices may not rise materially in 2024 as higher interest rates, withdrawal of tax incentives, and slowdown in demand due to slower employment growth may weigh on demand.

Gold: The gold prices have recently rallied on the back of expectations of aggressive rate cuts by central bankers and persistent buying by some large central banks. A weaker USD may further support gold prices in 2024. However, there is little to suggest any major rise in the global gold prices. Save for a major geopolitical escalation, gold offers a neutral to marginally negative risk reward from the present level.

Cryptocurrencies: In the past few years, Cryptocurrencies have emerged as a notable alternative asset class. Being a new asset class the level of understanding and awareness about this asset class is still low, though the participation has risen exponentially. This combination of low understanding - high participation makes it highly volatile. Nonetheless, its popularity remains high and this trend may continue in 2024 as well.

Fixed income: The corporate bond yields and deposit rates may see some downward bias in 2024, as policy rates peak and begin to descend. The yield gap that favors bonds presently may be sustained for most part of 2024.

Overall, in my view, the return profile of alternatives is neutral for equities.

Greed and fear index - Negative

Historically, the most successful, though intuitive, indicator of greed overtaking the fear in the stock market is the outperformance of small-cap stocks over large-cap stocks. The volatility index, another gauge of fear, has however inched higher in the recent weeks.

The sharp outperformance of smallcap stocks in 2023 indicates that greed dominates the sentiments presently. This sentiment may change in 2024 when the global news flow becomes ominous. The Greed and Fear balance therefore is unfavorable presently.

Perception about the political establishment - Positive

Strong commitment to promote manufacturing in India; the positive outcome of thrust on self-reliance, controlled fiscal balance, and recent election victories are keeping markets’ perception about the political establishment positive. A strong performance in the general elections may further strengthen the positive perception.

Outlook for Indian markets

Given the positioning of the above seven key factors, my outlook for the market in 2024 is as follows:

(a) Nifty 50 may move in a large range of 17390-23063 during 2024. It would be reasonable to expect a high single-digit return for the year on diversified equity portfolios.

(b) The outlook is positive for Non-bank financials, Fossil fuels, Construction materials, Capital goods, Infrastructure, Technology, Pharma, and Modern retail. Outlook for automobile is neutral. Large-cap stocks may outperform. Closely watch chemical space for the revival of fortunes.

(c) Benchmark bond yields may average 7.00% +/- 30bps for the year. Shorter end yields may continue to do better in 1H2024, while longer duration may do better in 2H2024.

(d) USDINR may average close to 83.5+/- 1 and move in the 81-85/USD range.

(e) Residential real estate prices may appreciate marginally and remain generally remain stable. Commercial real estate may continue to perform better.

Some key risks to be monitored for the market in 2024

Development of El Nino adversely impacting monsoon; and unusual rise in rural stress.
Worsening geopolitical situation in Europe and Asia.
A large credit event causing market freeze.
A deeper than expected recession in developed economies that may spill into 2025 as well.
Sharp rise in commodity prices due to production/logistic disruptions; restocking; displacement of USD etc.
General election results contrary to expectations.

2024: Investment Strategy

Asset allocation

2024 may be a challenging year for investors. The volatility and uncertainty may increase materially requiring investors to focus on capital preservation while attempting to generate reasonable returns. At the same time, the market may offer attractive opportunities to build a good portfolio for the period beyond 2024.

I shall maintain a standard allocation in 1H2024 and engage in active trading in my equity and debt portfolio to optimize return using the benefit of large swings. However, in 2H2024 I would look for opportunities in the emerging themes for the next decade and build a long-term portfolio. Maximizing return will not be my primary focus in 2024.

My target return for the overall financial asset portfolio for FY24 would be 11%.

Equity investment strategy

I would maintain 60:20:20 mix of large, midcap and smallcap stocks.

(a) Target 9% price appreciation from my core equity portfolio and 18% earning from my trading portfolio;

(b) I shall be overweight on Non-bank financials, Fossil fuels, Construction materials, Capital goods, Infrastructure, Technology, Pharma, and Modern retail.

Miscellaneous

I have assumed a relatively stable INR (Average around INR83/USD) and slightly lower short-term rates in investment decisions. Any change in these assumptions may lead to a change in the strategy midway.

I would continue to avoid directly investing in high-valuation new economy businesses like digital platforms and Fintech. I will also avoid international equities and gold.

Wednesday, October 4, 2023

1HFY24 – So far so good

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.

Thursday, September 7, 2023

Fx cover – some red flags to be watched closely

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.