Narayan Shroff (NS): Hello, and welcome everyone to our first monthly podcast for Barclays Private Clients India in this new year 2022. I am Narayan Shroff, part of the India Investments team, and I will be your host for this podcast.
In this month’s podcast I will share with you a broad synopsis of our India outlook for 2022, followed by two short interviews with our in-house guests Rahul Bajoria, Chief Economist, India and the Antipodes at Barclays, and Killol Pandya, Head of Fixed Income Portfolio Management at Barclays Private Clients India. They will share some of the relevant insights and outlook on the upcoming Indian Union Budget and strategies for the year ahead.
While we are definitely better prepared to tackle the COVID-19 variants and economically more resilient than before, this year is likely to be characterised by slower economic growth, higher inflation and elevated market volatility. Overall though, even with lower absolute returns than witnessed in the recent past, the outperformance of equities over bonds in Indian markets is likely to continue.
Macroeconomic factors show that while inflation is rising, it is broadly expected to remain within RBI’s comfort zone. Global commodity prices, especially across the agriculture, energy and metals blocks, have been firming up and pose the principal threat to this inflation outlook.
It makes sense as industrial growth continues to firm up with increasing capacity utilisation and domestic economic expansion, and early signs of capex cycle seems to be underway. The likely near term headwinds to growth such as US Fed tapering, fiscal constraints and potential hardening of interest rates may counterbalance the effects of rising inflation to some extent.
It is difficult to estimate the outcome of key events such as the annual Indian Union Budget to be presented on 1st February, but market expectations are of a growth oriented one. We will hear more on this topic from our guests shortly.
Corporate earnings are expected to continue to build on the fiscal year ’21 momentum, with FY22 and FY23 earnings estimates for NIFTY 50 remaining stable despite the several headwinds observed in 2021. Second half of calendar year is likely to be less volatile and drive maximum outperformance for equities.
Current valuations offer a limited scope for multiples expansion and, therefore, increase in corporate earnings could be the primary driver for market returns going forward. Hence, bottom up stock selection with focus on structural growth stories remain key.
Key themes that we see favourably placed getting into 2022 include technology and Digital 2.0, real estate and infrastructure, manufacturing with the private sector capex revival and supported by production linked incentive plans, banking and financials in line with the anticipated credit growth revival, retail sector re-emergence post COVID-19, chemical sector with the continuing China+1 strategy and supply chain normalisation.
To the discerning investors, 2022 should continue to bring exciting investment opportunities across both public and private markets, both in India and across the globe. On this note, we now have Rahul Bajoria with us.
Hi, Rahul. Thanks for joining us today. Rahul, what is our outlook on the upcoming Indian Union Budget and the fiscal policy?
Rahul Bajoria (RB): Hi Narayan. It’s a pleasure to be back on the podcast.
So, on the budget, you know, for fiscal year ’22/’23, you know, it will be presented against a backdrop of fairly renewed uncertainty around the new Omicron COVID variant. However, we do feel there is a limited fallout, economically speaking, from the current wave which should allow the government to continue its focus on medium term objectives such as improving the growth potential and also boosting the investment cycle while basically maintaining some semblance of fiscal discipline.
Our sense is that the Finance Minister Nirmala Sitharaman will continue to push on the fiscal pedal and also will support the economy effectively through other means. We believe that India's consolidated fiscal deficit will reach about 11.1% of GDP, effectively split 7.1% for the central government, 4% for the state government during the current fiscal year, and then this number will likely decline very gradually over the next five years towards 7% of GDP on a consolidated basis.
For the next year itself we think that the consolidation will be limited, most likely at about 10.5%, with about 6.5% to the centre, 4% for the states. We do feel that there will be ongoing higher welfare spending and, as you indicated, Production Linked Incentives (PLI) and subsidies linked to that will remain key fiscal priorities.
Overall, we sense that the theme of the budget will centre around improving capital expenditure and this will be pretty crucial for cementing the growth revival story as state governments are likely to struggle to increase capex given that they will be losing out on protected GST funds, which is also coming in the backdrop of reasonably weak private investment.
NS: Rahul, inflation is the other big topic on everybody’s mind. What is our outlook on inflation in India this year?
RB: So, as you would have seen, the December CPI numbers surprised slightly on the downside and we still think that keeps us on track for CPI to average about 5.4% in the current fiscal. And we actually expect it to moderate to about 4.5% in the next fiscal supported by some reversal in core price pressures, contained household inflation expectations and possible stability in global commodity prices.
We think that firms will continue to feel that there is persistence in higher input costs, which also means that in a reviving economy it may result in higher price pressures coming from more margin increase rather than necessarily cost increase itself.
Our overall sense remains that headline inflation will continue to stay within the 4-6% target band of the RBI which will effectively set the tone for a gradual monetary tightening in the coming months, but at a fairly delayed basis.
NS: So, Rahul, what is our outlook on the monetary policy and the yield curve in India?
RB: So I would say, the risk from Omicron notwithstanding, we believe that as overall risks to growth dissipate as we progress through the year, the RBI is reasonably on a calibrated path towards policy normalisation and our sense is that they will continue to normalise policy in the next meeting in February. We expect actual repo rate hikes to begin only in the next fiscal.
So, effectively from April onwards we think repo rate hikes are on the table, but we see only the scope for about 50 basis points of rate hikes most likely to be delivered by September itself.
We also feel that it’s imperative for clients to focus on the liquidity management strategy of the central bank and our sense is that over the next few months the central bank will be stepping up its liquidity absorption through the variable rate reverse repo window and also might be using auction cut offs to effectively direct short term market yields.
We also think that the RBI would try as much as possible to rely on organic drivers such as currency capital outflows to drain out some amount of surplus liquidity, especially considering the global backdrop we are in in regards to monetary policy. We don’t think that there is a probability of OMO sales being delivered by the RBI because that might be too severe for the market to digest. But, overall, we sense that, you know, there could be a bit of a flattening bias as far as the bond yields are concerned in the coming years.
NS: Thank you again, Rahul, for joining us today. We now have Killol Pandya with us. Hi, Killol. Thanks for joining us today.
Killol, given the recent Omicron spikes, what do you feel about the timing of RBI’s rate actions?
Killol Pandya (KP): Hi, Narayan, and thanks very much for having me.
The bond market environment at present remains fluid and we believe RBI is keen to retain policy flexibility to tackle emerging situations. Till recently it was felt that, with RBI initiating liquidity reduction steps, repo rate hikes would probably take place in the policies of February or April 2022. However, given the present situation, repo rate hikes may be pushed back to at least the July 2022 policy.
This could represent a year of two halves where the first half is likely to be one of stable reference rates like repo, but with uncertainties and tidal forces of markets providing continual volatility. The second half should provide greater clarity to participants on the monetary and fiscal policy fronts and we may see RBI harden rates and move towards normalisation of the monetary policy at that juncture.
For now, we are pencilling in a total of some 65 to 75 basis points rate hikes from the present overnight rate of 3.35%. A sudden spike in domestic inflation and an unexpected hawkishness in global rates, principally US rates, are key risks to this outlook. Other things remaining the same, the peak 10 year sovereign rate in India should be in the habitat of 7%, give or take 20 to 25 basis points.
We are also fairly certain of continued RBI action to influence the shape of the yield curve which it has officially stated to be a public good. RBI is likely to prudently use all instruments at its disposal such as TLTROs, OMOs, Operation Twists, VRRRs etc to influence market liquidity and yields throughout the year. Of course, these steps by RBI may contribute to continuing market volatility.
NS: So, Killol, what is your preferred bond PMS portfolio positioning for 2022?
KP: As I mentioned, our view is that the year will be a year of two halves and the portfolio management strategy for the two halves will also need to be different. As such, in the first half the situation should remain fluid and volatile due to US rates, global oil prices and third wave, fourth wave concerns. We expect the Union Budget in February to be growth oriented and in its February policy RBI is likely to keep repo rates stable.
For the first half, therefore, a twin pronged strategy of conservative duration positioning in liquid assets and a rolldown strategy may be appropriate for clients who are already invested. Within the preferred one to five year segment, one may engage in some duration bar belling, but this is what is appropriate for the first half.
In the second half there’s a good chance that global interest rates will rise and India will eventually follow suit, probably in the early second half of 2022. We expect RBI to tighten liquidity and rates and so yields should harden towards our targeted zones. As we approach that habitat one may look to add duration, and based on the degree of economic resurgence at that juncture also look to add quality, higher yielding assets including non-AAA assets to the portfolios.
Throughout 2022, we feel the tidal forces of market concerns on one side and mitigation by RBI and the government will provide opportunities which one may use to add alpha. In the recent past, markets have shown the tendency to overreact in face of concerns and this can be used effectively to add alpha to any portfolio. If markets overact to RBI’s hardening and, for example, the 10 year sovereign adjusts materially above 7.10-7.25% that would be a great time to actively start adding duration.
Going ahead, as the anticipation of rising rates gets baked in, shorter end assets may see increased interest leading to continuation of the steepness in the yield curve. Some government borrowing may be deputed to PSUs to control deficit numbers and we may see a resumption in issuance by PSU entities, especially the infrastructure, power, roadway entities, which are typically issuing at the longer end of the curve like 10 to 15 years.
This will provide a steady supply of the so called gold-plated securities and may keep the corporate AAA bond curve steep in the long term. In the context of rising rates this situation may provide a basis for a good hold-to-maturity strategy.
As such, here onwards, we feel fresh allocations should be staggered and investments should aim at participating in the rate increases as they happen.
NS: Thanks, Killol. My last question for the day, what is our credit outlook for 2022?
KP: There has been a distinct lack of market interest in non-AAA and relatively higher yielding issuers in our bond markets for the past two to three years. Lack of liquidity and concerns regarding credit robustness have been the obvious drivers behind this behaviour. But going ahead, India’s economic revival and resilience is giving more confidence to our credit outlook.
Looking past short term blips caused by localised spikes in the pandemic, we are likely to see balance sheets get stronger on the back of resurgent earnings situation in the second half of calendar of 2022. In turn, this view gives us more confidence to consider non-AAA and higher yielding assets.
At a portfolio level, adding accrual by increasing exposure to relatively lower credit papers remains an option on the table. But the approach towards lower credit issuers should remain critically dependent on investor appetite for risk and volatility. Also, given the flow and ebb of global volatility and uncertainties surrounding the pandemic, as of now it is appropriate to be careful and gradually increase the investable universe.
One thing we must also keep in mind is that post normalisation, the competitive environment within sectors may be different than earlier and so relatively lower credit stock picks need careful analysis.
We remain biased towards sectors that stand to benefit from government policy and budget announcements such as power, MSME financing, rural housing, rural infra etc, but a bottom up approach remains critical while adding names to the investable universe. In that context, one may look to add rerating stories to the portfolio where one can benefit in the medium to long term.
NS: Thank you again, Killol, for joining us today.
KP: Thank you, Narayan, for having me on this podcast.
NS: With this we come to an end of our podcast. Thank you for listening to us. We wish you all a happy, safe and prosperous new year.