Monthly markets podcast India December 2022

Narayan Shroff (NS): Hello, and welcome everyone to our monthly podcast for Barclays Private Clients India. I am Narayan Shroff, part of the India Investments team, and I will be your host for this podcast.

This month we have two of our in-house guests, Julien Lafargue, Chief Market Strategist at Barclays Private Bank, and Rahul Bajoria, Head of Emerging Markets Asia (ex China) Economics at Barclays. In the next few minutes we will share some of the key insights, macroeconomic perspectives and market strategy from our Outlook for the year ahead, both globally and in India.

Thank you both for joining us today. Julien, let me start with you first.

Julien, what is our take on global growth and inflation in the coming year? Specifically, what could surprise the investors?

Julien Lafargue (JL): I think the main message when it comes to growth and inflation is that we expect lower growth and lower inflation in the major economies. One, inflation, is in fact the result of the other, lower growth. Central banks globally have been hiking aggressively in 2022 in order to tame inflation. While higher rates do nothing to prices they do slow the economy which in turn should lower demand and therefore slow inflation. 

In terms of actual forecast we believe global growth will slow to 1.7% in 2023 down from slightly more than 3% in 2022. Headline inflation meanwhile should slow from 7% this year to 4.5% next year. There will be significant divergence at the regional level though. Europe and the UK in particular should experience a GDP contraction of 0.8% and 1%, respectively. In the US GDP growth should be flat while emerging market will grow by around 3%.

The main surprise, I think, could be around both growth and inflation as these two are linked. On the growth side, expectations are for a significant slowdown and if the outcome is better than expected then investors could be caught wrong footed. Similarly, inflation could turn out to be stickier or more benign than anticipated.

NS: What is our call on Equity and bonds correlation going into the next year?

JL: Well, equities and bonds correlation has been a major talking point and feature of this year. In fact, we have seen unprecedented and coordinated move lower in both asset classes with bonds failing to offer the protection they normally provide. We believe both asset classes could remain positively correlated until we have more clarity around central banks’ next moves. This should happen sometimes in the first half of 2023. After that, we would expect bonds and stocks correlation to return to a more normal regime. This means that we still see merits in owning both stocks and bonds as part of a diversified portfolio.

NS: Thanks Julien. So, what is our outlook on global equities and where do opportunities lie?

JL: I think here we need to differentiate between the short term and the medium to long term. In the short term, we believe that stocks aren’t hugely attractive. This is not to say that we expect significant underperformance of the asset class but when you compare stocks to bonds, the risk-reward appears slightly more compelling on the bond side given the yields now available. At the same time, stocks are still facing a headwind in the form of negative earnings revisions. But this should change at some point in 2023. And when considering the medium to long term outlook, equities are in fact more appealing today than they have been in the last 12 or 18 months. This is because we have seen a significant re-pricing in terms of valuations. To put some numbers around that, at the beginning of the year, cyclically adjusted price to earnings ratio where implying returns of around 6% per annum for the next 10 years. Now, they point to returns in excess of 8% per annum over that same period.

In terms of opportunities, first and foremost we think that stock picking could be an important contributor to returns because we see a lot of dislocation at the stock level.

Now, at the sector level, we see opportunities in banks and energy. In the case of banks, their relative performance has lagged the sharp rise on bond yields. This is mostly we believe because investors are fearful of possible deterioration in credit quality. If and when they realize that the upcoming slowdown in global economic growth won’t be as bad as feared, this gap should close, allowing the sector to outperform.   In the case of energy, we believe that the recent outperformance does not fully reflect the improvement in the sector’s fundamentals. In fact, despite being up 50% year to date, from a relative performance perspective, the sector is just back where it was in 1998. At the same time, earnings have improved to the point where they are almost back to where they were at their previous peak. Again, we feel this is unjustified, especially when energy stocks could prove to be a valuable hedge against inflationary pressures.

NS: Yeah, thanks, Julien. So, where do we see better opportunities in emerging market equities?

JL: I think one market every investor needs to keep an eye on in 2023 is China. This is because the country looks to be willing to gradually reopen and soften its stance around zero-COVID policy. Now this process will be complicated and lengthy but if China does reopen, there could be substantial upside to Chinese asset prices. This is because the asset class is widely unloved and under-owned currently.

Now, India is also an interesting emerging market in our opinion. Economic growth is much stronger than in China and investors may still have concerns around the regulatory risk in China. As such, India appears like an attractive alternative and that has shown in 2022. Of course for emerging markets and especially oil importing economies we need both commodity prices and the US Dollar to be relatively stable or decline to provide further support.

NS: Thank you Julien. Turning to you Rahul and thanks once again for joining us on the podcast once again.

Rahul, can you share the key takeaways from the “India: Macro Stability Perspectives” series you have published recently?

Rahul Bajoria (RB): Thanks Narayan. Two things stand out in India’s policy choices as it reacted to the twin shocks of the COVID-19 pandemic and the current European crisis. First, during the post-pandemic period, India’s fiscal response was largely targeted at improving supply side infrastructure in the economy and did little to stimulate domestic demand- which was in contrast to consumption boosting measures undertaken across the world. Second, as geopolitical crisis in Europe started disturbing the global commodity markets, India has opted to deploy fiscal resources to shield domestic economy from import price rise. Be it fertilizers, edible oils or energy prices, government deployed fiscal resources to shield domestic consumers. It is these tough macro choices that India took that helped keep the macro stability intact for the economy, and paved way for remaining the fastest growing major economy in the world.

But there are limits to the way such a strategy can be adopted. Given the rising fiscal burden due to higher subsidy costs, further fiscal space remains limited. Robust growth could prevent India's already large current account deficit from narrowing, even if commodity prices continue to recede at the margin. Maintaining control of the external deficit is likely to be key to preserving macro stability. Already, both external and fiscal financing requirements have risen tremendously through the pandemic, putting pressure on exchange rates and bond yields. India faces trade-offs over growth and external balances, and between inflation and fiscal policy, while monetary policy attempts to balance these competing forces.

NS: Yeah, thanks Rahul for summarising the deep analysis you have presented in that series of publications. So Rahul, in a multipolar world with deglobulisation and friend-shoring being the emerging popular themes, what are the key opportunities for India?

RB: India remains a beneficiary of some of the evolving global trends. With its demography, and lower labour costs, India presents a top opportunity for countries pursuing the ‘China+1’ strategy. In addition, India’s deft manoeuvring of the geopolitical tensions over the past few years, has left the country on the right side of key global rivalries.

On the economic front, the inherent strength of the Indian economy also remains its domestic orientation, with private consumptions being the dominant engine of growth. As a consequence, while no country can avoid the cost of changing global backdrop, the implications for the Indian economy will be relatively minimal.

NS: So Rahul, in the wake of a reverse inflation differential between India and western developed markets and considering India’s external balances, what could be RBI’s currency management and monetary policy in the coming year?

RB: So, Narayan, the reversal of inflation spreads is a key trend that has evolved over the past year. As I suggested earlier, India’s deployment of fiscal tools to insulate domestic prices has ensured that volatility in inflation has minimized, and inflation in India is now lower than what is being observed in developed economies. Indeed, inflation differential are unlikely to be a contributor to currency depreciation in the near future. However, while fiscal intervention could curtail imported inflation, the blow up in current account deficit was inevitable. In addition, the risk off sentiment prevailing across the globe have also led to limited capital flows into the economy, raising funding concerns.

Still, strong growth and favourable inflation differentials mean that Indian Rupee will remain relatively better performer in the near term.

While inflation has started to moderate in India, 10 consecutive months of above target inflation, and evolving risks would warrant caution from policymakers. We see room for further rate hikes from the RBI, especially at the policy meeting on 7th of December, where we expect the Monetary Policy Committee to hike repo rate by 35 basis points. Given the real rates in Indian economy are already approaching the desired levels, the need to tighten financial conditions any further will be minimal, in our view.  With the global backdrop deteriorating, the RBI's monetary policy will need to manage the growth/current account and fiscal policy/inflation trade-offs.

NS: Thanks Rahul and Julien once again for joining us and sharing those insights.

Coming to Indian equities, as both Julien and Rahul eluded to, backed by encouraging GDP growth, Indian equities have shown much resilience this year, compared to the slumps in valuations seen among global peers. This trend is likely to continue in the coming twelve months.

Although not our base case, a key risk remains of persistently higher imported inflation, especially if oil prices shoot up, or if the rupee suffers a sharp depreciation.

Overall, liquidity tapering by leading central banks is expected to add to downward pressures, squeezing the availability of capital and increasing the cost of it. However, we also note that there seems to have been a structural fall in the cost of capital for Indian companies, aided by its more competitive global status, prudent fiscal and monetary policies, and recent fiscal reforms.

We anticipate that global and local investment risk allocations to keep supporting flows into Indian equity markets, albeit the quantum of domestic activity may not be enough to compensate for any sharp global outflows. This is especially the case as local bank deposit rates and bond yields now appear attractive for domestic retail investors.

That said, with valuations around their long-term averages, high volatility with frequent rotations across sectors and themes may continue to be a theme of the coming year as well.

The banking and financial services sector is expected to benefit from the surge in interest rates seen in 2022. It remains a high-beta play on the Indian economy. In addition, the banking sector is stronger financially after the recent consolidation activity seen among banks.

The amount of non-performing assets is at its lowest levels since 2016. Large lenders should continue to benefit from higher lending rates, a lower cost of liabilities, more cost-saving measures, and enhanced market share, aided by better digital infrastructure and digital adoption.

With one of the largest and fastest growing domestic consumer markets, we expect to see more focus from investors on the Indian consumer sector. Higher spending by the central and state governments, agricultural growth, as well as travel and leisure, retail, and construction activity are likely to support higher employment and wage growth, supporting high-street demand. Increasing private capex flows should further accelerate this trend.

Among consumer staples businesses, “premiumisation” is expected to drive demand in urban India. Meanwhile, sustained growth in rural India, coupled with price easing in key commodities such as crude and palm oil, could lead to margin expansion for fast-moving consumer goods area. Quality companies will likely benefit from a shift to the “organised” sector from the “unorganised” one.

Consumer durables will likely be backed by growth in disposable income as the number of middle-class members and per capita income expands, a relatively young population, more urbanisation, and a boost in female employment numbers. This should play out across white goods, fashion and accessories, and home improvement, amongst others.

The auto sector should particularly benefit from an ongoing easing in the shortage of chips seen this year, along with increased demand for passenger vehicles and two-wheeler volumes. A nascent switch to electric vehicles from fossil-fuel-powered alternatives should also provide opportunities for manufacturers.

After a long hiatus, a capex and manufacturing boom cycle appears likely in the country, well supported by positive reforms, policies, and incentives. A wide variety of segment leaders across cement, power, defence, industrial construction, chemicals, and energy transition are well positioned to provide superior earnings growth in coming years.

Improving digital infrastructure and adoption should keep fuelling growth for goods and services delivery e-commerce platforms. Investor sentiment towards this segment and rising valuation discounting rates will probably keep valuations under pressure, especially for the loss-making companies.

On the other hand, IT services, domestic-oriented pharmaceuticals and healthcare, real estate, infrastructure, and logistics sectors are expected to perform in line with the market next year. However, those companies with the biggest market share should continue to boost this share and command premium valuations.

Coming to domestic fixed income assets, we expect to see a long pause for interest rates in 2023, but would keep an eagle-eye on any growth-led inflationary impulses that may push the central bank to hike rates again. The interest rate curve may “bear steepen” towards the middle of the year, with longer-end rates still under pressure from increased bond supply (persistent government spending ahead of elections in 2024 and increased private credit demand) and the central bank’s draining of liquidity stance not supporting the case for the Reserve Bank of India to conduct much of its open market operations purchases.

We continue to prefer the high accruals available in the 3-7-year segment of the yield curve. Also, even at a pessimistic case of the terminal repo rate at 6.5%, a blended portfolio of the 3-7-year sovereign bonds and high-quality corporate assets, with the current term spreads at around 75 to 100 basis points and with an investment horizon of at least 12 to 18 months, could produce gains beyond the accruals, should the rate path be more benign and due to the roll-down benefit over the investment horizon.

Given our constructive view on the economy, certain high yield segments may offer good opportunities to enhance portfolio yield. We expect credit spreads to widen and create occasional opportunities to increase exposure to the sector.

After a tough year for investors, sticking to your long-term asset allocation strategy is key, while keeping an eye on opportunities to rebalance portfolios in market sell-offs.

For Indian investors, foreign equities, especially in developed markets, have seen sharp corrections in 2022. With the markets priced for worst case scenarios, this may amplify opportunities to capture appealing risk-adjusted returns and diversification opportunities.

Private markets have cooled off from the frenzy seen in 2021 and early 2022. However, they should continue to offer opportunities to diversify portfolios in private equity and private credits.

In real assets, exposure to real estate investment trusts and infrastructure investment trusts can act as an inflation hedge, while gold backed securities can act as both an inflation hedge and a safe-haven in volatile times, while also helping to diversify portfolios.

With this, we come to an end of our podcast. Thank you for listening to us. Stay healthy and invested, and wish you a great year ahead.