Monthly markets podcast India March 2022
Narayan Shroff and Jean-Damien Marie discuss how investors can buckle up for the potentially bumpy ride ahead, as well as casting their eyes over longer-term trends.
Against a backdrop of elevated inflation, weakening growth and tighter financial conditions, Rahul Bajoria, Barclays’ Chief Economist for India and the Antipodes, addresses the key challenges and opportunities facing India as we enter the critical monsoon season. And Narayan Shroff, Investment Director for Barclays Private Clients India, provides his usual monthly round-up of India’s financial markets after a rocky period for investors.
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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.
I will start with a short interview with our guest Rahul Bajoria, Chief Economist, India and the Antipodes at Barclays. Rahul will address some of the key questions around challenges and opportunities facing India from a macroeconomic perspective. In the following few minutes, I will share with you our broad economic and market outlook and our investment strategy for the period ahead.
Hi, Rahul, thanks for joining us today. Rahul, what is our outlook on inflation in India, and what could be the key components or the drivers putting upward and downward pressures?
Rahul Bajoria (RB): Thanks, Narayan. Good to be back here. So, as you know, inflation has reached fairly elevated levels, and even though we have had a slight decline from the month of April to the month of May it is unlikely to recede any time soon. It does appear that, you know, RBI is set up for the first official breach of its inflation targeting framework as it is expecting CPI inflation to average 6.7% for the current fiscal year, which will involve missing inflation target for three consecutive quarters.
However, it is very important to note that the high inflation is a global phenomenon, both in terms of its origin and the expanse. Global central banks, as you are aware, are all battling together this inflationary pressure. At the same time, there is very little evidence, at least in India, of any demand led spike in domestic inflation numbers and it is mostly imported components across food, fuel and other key intermediate products which are the key drivers of the recent inflation episode.
Increasingly, pressures in some ways are seasonal factors as well. We have seen prices of vegetables and fruits, which typically do rise during the summer months, they have been rising as well and while we are not very concerned about them as they tend to reverse course it is creating a bit of a near term headwind.
We believe that, given the nature and drivers of the recent inflationary bout, it is absolutely important that a co-ordinated approach is seen between monetary and fiscal authorities to bring the inflation genie back within the bottle.
Fiscal interventions have already happened, to an extent, through enhanced subsidies, excise duty cuts on fuel, export bans, and these are all likely to help at least reduce the domestic price pressures that are going to come about. Still, there is perhaps more room to undertake more measures to insulate domestic consumers from the global price gyrations.
NS: Yeah, thanks, Rahul. So, what is our growth projections in the country and what would be the key drivers? Do we see it getting more broad based and better entrenched? What are the key risks to these assumptions, and do you see this impacting the monetary policy stance getting into 2023?
RB: So, in the very near term we expect India to still post a reasonably healthy number of 7% growth for the fiscal year 2022-23, which is slightly lower than the RBI’s estimate of 7.2%.
I think, so far, the growth recovery, especially after the Omicron wave, has been reasonably resilient despite the intensifying headwinds. We have seen elevated input costs, you know, some tightening in financial conditions, and a very worsening global backdrop, you know, which can potentially have some impact on the domestic growth outlook.
However, you know, the forecast of a normal monsoon does bode well for rural incomes and agriculture output. We also feel that, you know, some of the weakness in the contact intensive trade and hospitality sector is likely to, you know, reverse itself which should help at the margin as well.
Overall, we do think that in the coming months at least we should see the recovery spreading far deeper into the service sector, which is absolutely critical for the Indian economy. However, there is going to be some pressures from supply shortages, higher input costs which could impede the recovery in manufacturing sector. Given the elevated commodity prices, our net exports also are likely to remain under pressure which is likely to shave away from the overall GDP figures.
Still, we reckon that the monetary policy stance of the RBI will remain focused on fighting inflation at least throughout 2022. We do not think that the RBI will hesitate in tightening financial conditions at least in the near term to temper domestic demand as it tries to bring inflation back within its target time.
However, the policy trajectory of 2023 is likely to remain fairly uncertain given the global backdrop, and it will also remain quite contingent on growth dynamics as we believe that any material tightening of financial conditions will require very strong evidence of sustainability of the growth recovery itself.
NS: So, Rahul, what are our projections on the path and peak of the current rate cycle, systemic liquidity and the shape of the yield curve in the country by 2023? What has changed recently for a material change in our projections?
RB: So, the messaging from the RBI has been reasonably clear that inflation management is its key priority, at least in the near term, and this will require some growth sacrifice. Over the next three meetings in terms of the sequencing we now expect the RBI to deliver a 35 basis point rate hike in August and is likely to move in clips of 25 basis points each to 5.5% in October and it is likely to switch to a neutral stance in the October meeting as well
We do think that they will move again in December to 5.75% which we now believe is going to be the end of the tightening cycle. We believe this will allow the RBI to signal that it has moved beyond neutral levels and is holding a policy stance towards tightening while it will, you know, continue to assess the growth and inflation situation and then take a call on whether further tightening is required or not.
On the liquidity front, Narayan, we think that it continues to shrink, at least in the near term, as both the autonomous drivers, you know, currency in circulation and capital outflows are likely to be a drag on systemic liquidity. If capital outflows continue to remain at the current pace, we believe the liquidity levels should reach closer to neutrality, which might give the RBI some room to offer support to the government borrowing programme, without necessarily stoking inflation at least over the medium term.
However, successive upside surprises in inflation, you know, which has been a feature driven primarily as a fallout of the Russia/Ukraine conflict across multiple domains, remains the key focus area for the enhanced response that we are seeing from central banks, and we reckon that this will be a focus for the RBI as well, at least in the near term.
NS: Yeah, thanks, Rahul. Indeed, getting the pace of policy normalisation and the peak rates right, as you described, can help investors take good long term investment decisions beyond the near term volatility.
So, Rahul, in the light of recent pressures felt across the emerging markets, do you see the external balances and currency management in India continuing to help attracting foreign investments and flows into the country?
RB: So, this has been an emerging area of policy challenge that we can certainly see. I mean the rupee has come under some pressure of late, but as Governor Das recently pointed out in his latest monetary policy statement that the impact of the global headwinds on the Indian rupee have been reasonably mild, and the INR continues to be among the better performing currencies at least across its peers in emerging markets.
However, you know, our trade deficit has ballooned to record levels recently, which was expected given the elevated commodity prices that we are seeing across a wide variety of products that we import. However, you know, the export performance has also remained fairly robust, and this probably remains a bit of a silver lining in the current environment.
It also is worth pointing out that the import cover remains reasonably healthy, and the RBI is in possession of more than $665 billion of foreign reserves, you know, which should help the central bank in fighting any undue volatility in the currency.
We do think that, you know, this period of outflows is unlikely to sustain and a return to strong growth is likely to remain the key attracting force behind India’s capital markets, you know, as it sort of looks towards the medium term and its stability. Even with a fairly modest 7% growth, India should still remain, you know, the fastest growing major economy in the world which should keep our investment attractiveness reasonably intact, at least over the medium term.
NS: Rahul, let me end this by asking you the key question that should matter to long term investors. At a macro level, where do you see India’s economic and geopolitical position in the world in the next three to five years from now?
RB: So, Narayan, India remains on track to become the world’s third largest economy by the end of this decade, and perhaps also the world’s most populous country, at least as far as UN projections are concerned. We also do not see any major difficulty in the country achieving its target of hitting $5 trillion GDP perhaps by 2026, and it is likely to hit close to around $10 trillion some time by the early to the middle of the next decade.
Strong growth, of course, remains the key ingredient to achieve our national security objectives as well, whether it comes through defence spending or just the economic health that the country would enjoy.
What’s been interesting is that India has shown a fair amount of interest in recent months in stepping up its free trade agreements with a series of countries like Australia, UAE, you know, there’s one being negotiated with the UK, with Israel and that in turn I think also has an element of security around supply chains and also making India a fairly important player as far as global manufacturing is concerned.
It’s also worth pointing out that, you know, we do remain in a fairly active neighbourhood, and some of the frictions that started with China in the summer of 2020 are likely to have a significant impact on some of the geopolitical choices that the country is making both in economic and security terms.
I think the rapid progress that’s been made on the QUAD and the breakthrough in some of the ongoing negotiations between the Chinese and Indian diplomatic teams in recent months probably allows India, you know, to be friendly with everyone while at the same time looking after its own real politic, you know, geopolitical ambitions which will, you know, provide a fair amount of security and assurance as far as our own national strategic objectives are concerned.
NS: Yeah, thank you again, Rahul, for joining us today.
RB: Thank you, Narayan, for having me on the podcast.
NS: Now, coming to the financial markets, domestic Indian equities saw more volatility and a sell off from foreign investors. After rallying over the two years, the market seems to be in a consolidation phase. Although valuations are lower, they continue to outperform other emerging markets.
The pessimism in local markets is largely focused on the implications of rising global interest rates and inflation for the Indian economy. We believe that these factors will contribute to prolonged volatility.
With the US Federal Reserve and other central banks unleashing an aggressive hiking cycle this year, earnings growth will be vital to sustain valuations. So far, many companies have reported margin pressures in all sectors due to climbing wage bills, raw material expenses, and oil prices. Luckily, the government is keeping the accelerator on with spending on capex projects. As such, the hit to demand in India may not be as bad as initially thought.
Investors seem to be moving capital away from emerging market assets. However, domestic flows have helped to protect the effect of this shift on small cap companies, whereas large caps have suffered considerable outflows, given that overseas investors have typically favoured quality and growth stocks. The recent sell off in these stocks has borne the brunt of the market correction over this period. As the fundamentals for quality and growth companies are largely unchanged, the resulting subdued prices suggest that they offer attractive entry points.
One sector where valuations have been hit hard is information technology services on concerns that a possible slowdown in the US may reduce IT budgets. However, with fairer valuations for the sector now and a strong earnings outlook over the medium term, in our view, the share prices in the sector may bounce back over the rest of 2022.
While there may be some earning downgrades in the coming weeks and months, hints of sustainability in underlying demand and predictions of a normal monsoon season should support markets.
We believe that this period of elevated volatility and sector rotation has further to run. As such, we anticipate more scope for bottom up stock selection. Beyond the near term turbulence, we may be at the beginning of a capex driven economic and earnings cycle. Any sharp fall in quality sustainable businesses with the potential for strong long term earnings growth should present investment opportunities. We prefer active management and have no bias towards large or mid cap stocks.
Now, coming to Indian bond markets, yields climbed in May and continued to do so through the June monetary policy meeting, supported by well received fiscal and monetary measures from the government and the central bank respectively. However, with the RBI increasingly focusing on inflation, bond investors are likely to remain anxious. On the other hand, policymakers may want to keep managing the shape of the yield curve with the aim of changing the market dynamics for demand and supply while providing intermittent support to bonds.
The global geopolitical and macroeconomic situation remains a source of volatility and adds uncertainty to prospects for growth and inflation in the country. Moreover, the market will likely have to price in a larger bond supply premium given the uncertainties unleashed by the recent fiscal measures. This is expected to keep pressure on yields in the near term.
As Rahul just highlighted, over the next three meetings, finishing in December, we now expect repo rates to reach 5.75%, which may mark the end of this cycle. A term spread, that is 10 year government bond rate over the repo rate of 175 to 200 basis points or higher, would be well above its long term norm at a time when the rates may reach a pause state offering opportunities to add duration to a debt portfolio.
In the short to medium term, we prefer bonds with maturities of between three and seven years with the flexibility to add duration as the yield curve changes. Again, assuming a medium term peak repo rate of say 5.75% to 6%, a term spread of more than 100 basis points would be above its long term average, assuming rates being on hold at that stage, in providing an attractive opportunity at current levels of government bonds in this segment. With a bond supply overhang and in a frontloaded rate hiking cycle, this means that opportunities may also occur in corporate bonds as the spreads widen.
However, investors should have appropriate risk appetite to remain invested through periods of intermittent spikes in volatility. Staggering allocations could help to manage portfolio performance at such times.
With this, we come to an end of our podcast. Thank you for listening to us. Stay safe and healthy, and happy investing.
Narayan Shroff and Jean-Damien Marie discuss how investors can buckle up for the potentially bumpy ride ahead, as well as casting their eyes over longer-term trends.
With escalating Russia-Ukraine tensions and inflation worries testing investors’ nerves, our India podcast host Narayan Shroff, Investment Director at Barclays Private Clients India, looks at whether the country’s outlook has changed, and what we can expect in 2022.
With the Indian economy rebounding from its Omicron test, our podcast host Narayan Shroff, Investment Director for Barclays Private Clients India, looks at how equity investors can position for opportunities in this volatile macro environment.
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