Nifty declined 3.1% in February 2022 following a flattish January as the Russia-Ukraine conflict significantly impacted crude oil and other
commodity markets leading to a risk of sharp input cost increases across several industries as well as potential negative impact on economic
growth. FII selling continued unabated for the 5th month in a row. The BSE Mid-cap index declined 5.1% while the BSE Small-cap index slipped
by 8.8% significantly underperforming Nifty.
Global equities continued their decline in February (-2.7% MoM). Escalation of geopolitical tensions over the past few days has materially increased the risk of potential trade disruptions of oil, gas, grains and metals and has turned into a significant risk for the global economy. Indian equities declined 4.1% (US$ terms) trading lower than broader markets in February (MSCI APxJ/EM: -1.4%/-3.1%).
Worldwide, most major indices corrected sharply with the US S&P500
down 2.9%, Euro Stoxx dipped 3.6%, Hang Seng declined 4.6%, Nikkei
dipped by 1.8% and FTSE UK slipped by 0.8% during the month.
In sectoral trends, only Metals (+9.5%) outperformed supported by
a jump in underlying commodity prices on the back of geopolitical
concerns, most other key sectors ended in the red for the month. Among
key sectoral indices, Real Estate fell 9%, Autos slipped 7%, Bankex dipped
4.4%, IT was down 3.6%, and Healthcare fell 3% (MoM).
FIIs continued to remain net sellers of Indian equities in February (-$4.5 bn, following -$4.8 bn in January). This marked the fifth consecutive month of net equity outflows for FIIs.
DIIs recorded inflows of $5.6 bn in February, maintaining the buying trend observed since March 2021. Mutual funds and Insurance funds were both net buyers in February with $1.4 bn inflows and $4.2 bn inflows, respectively.
Finance Minister presented a growth-oriented Budget for FY23 with a focus on infrastructure spending and boosting domestic manufacturing. General consensus among economists is that budget estimates are realistic and a 6.4% fiscal deficit for FY23 is achievable.
RBI at its latest monetary policy meeting kept Repo and Reverse repo rates remain unchanged at 4% and 3.35%, respectively and reiterated its accommodative stance to support the economy.
Q3FY22 real GDP slowed sharply to 5.4% (vs. 8.5% in Q2FY22), missing consensus estimates by 50bp. Key highlights were:
i) Industry and capex growth were weak (0-2% YoY)
ii) Improving services momentum.
iii) Nominal recovery remains strong, aiding tax collections and corporate profits.
CPI Inflation rose to 6.0% (YoY) in January from 5.7% in December, in line with expectations. Core inflation also remained elevated at 6.0% vs 6.1% in December.
Index of Industrial Production (IIP) growth moderated to 0.4% (YoY) in December from 1.3% in November, lower than expected. Weak December numbers also continue to reflect the impact of supply bottlenecks like semiconductor chip shortage.
India’s Manufacturing PMI (54) and Services PMI (51.5) remained in the expansion zone in January but witnessed a fall from their December levels. Services PMI witnessed a larger fall due to Omicron-related disruption.
India’s FX reserves are close to their all-time peak, standing at $633bn currently. FX reserves declined by US$0.8 bn in the past 4 weeks. INR depreciated over the month (down 1% MoM) and ended the month at 75.34/US$ in February.
Benchmark 10-year treasury yields averaged at 6.76% in February (15 bps higher vs. the January average) as plans for high government borrowing spooked the market. On month-end values, the 10Y yield was up and ended the month at 6.77% (up 9 bps MoM). Oil prices continued their momentum from the previous month, gaining 10.9% in February on the back of geo-political concerns.
Fiscal deficit for April-January came in at Rs 7.61 tn, or 50.4% of the budgeted FY22 deficit (at Rs 15.1 tn, or 6.8% of GDP). GST collections in February came in at Rs 1.33 tn (marginally lower than January collections of Rs 1.4 tn), up 18% YoY.
India emerged relatively unscathed from the Omicron wave in January 2022; thanks to a high level of vaccination and lower virulence, however, the global macro-economic back drop has become more challenging and highly uncertain driven by recent geo-political events. A sharp jump in crude oil prices have will not only lead to a widening current account deficit for India but also negatively impact overall growth.
Supply chains for several other commodities are also getting impacted leading to a surge in prices for fertilizer, coal, metals, etc. which is likely to result in high-cost pressure for corporates and consumers and could lead to a slowdown in demand if the disruption continues for an extended period of time. However, higher govt. spending on infrastructure and measures to boost domestic manufacturing along with RBI’s accommodative stance should provide some offset. Overall, we continue to remain constructive on the economic recovery cycle and Indian equities going forward.
Source: Bloomberg, MSCI
The past month has seen volatility across asset classes, with geopolitical tensions
around Russia and Ukraine taking center stage and continues to remain the focal
point going forward. Commodity prices and especially energy prices have seen an
upsurge. Crude prices broke the psychological USD 100/bbl mark and are currently
trading even higher at USD 115/bbl due to concerns around supply outage. Crude
prices at such elevated levels for a prolonged period will feed into domestic inflation
and further widen the Current Account Deficit.
Although, RBI had retained their inflation projections in the Feb 2022 MPC meeting, upside risks to the projections have meaningfully increased. Another fallout of the conflict in Ukraine is that Indian equity markets have seen FPIs pulling out money. This has resulted in some conversations around deferring the LIC IPO, although no concrete announcement to this effect has yet been made.
With inflation pressures being seen globally, markets continue to witness various economies exiting from ultra-easy monetary policies, with Central Banks globally hiking interest rates to stem the spiraling inflation. CPI print in the US for January 2022 came in at 7.5% (four-decade high), with Core CPI also edging higher to 6.0%.
In one of the recent interactions, the Fed Chairman has reaffirmed that the FOMC is on track to raise interest rates this month with expectations of a 25 bps hike this policy, followed by further hikes through the course of the year. He also indicated that the FOMC will decide the pace of reduction of the Fed’s balance sheet in this policy. The 10-year US Treasury yields breached the 2.0% mark during the month with expectations of higher rate hikes and faster policy normalization during the year than earlier expected. However, with the ongoing geopolitical crisis picking up and risk-off sentiment setting in, the 10-year US Treasury yields have fallen to 1.70%.
In the wake of the ongoing crisis, US, UK, EU and other nations have imposed economic sanctions on Russia, including removing major Russian banks from the SWIFT system. Rating Agencies have cut Russia’s credit rating to junk. With a sharp depreciation witnessed in the Ruble, Russia’s Central Bank has raised key interest rates sharply from 9.5% to 20.0%. Any embargo imposed on Russian Crude will remain a key monitorable going forward in determining the future course for Crude prices.
The 10-year benchmark G-Sec yield closed at 6.77%, up by 09 bps from its previous close of 6.68% while that on the short-term 1-year bond ended 10 bps higher at 4.60%.
In the corporate bond segment, yields rose across the yield curve over the month. The 10-year AAA bond yield ended 01 bps higher at 7.11%, while the short-term 1-year AAA bond yield ended 10 bps up at 4.95%.
The spread between 1-year and 10-year AAA bonds narrowed. Within the shortterm segment, the yield on 3-month commercial paper (CP) was up 10 bps to 4.05% while 1-year CP yield was up 15 bps at 4.95%.
On the domestic front, CPI inflation for January 2022 came in at 6.01% (vs 5.66% in December 2021) due to an unfavorable base effect in vegetable prices pushing food inflation higher, with Core inflation continuing to remain sticky. WPI inflation for January remained elevated at 12.96% (vs 13.56% in December 2021). This was the tenth consecutive month with WPI print in double digits.
IIP data for December 2021 came in weak at 0.4% (vs 1.3% in November) partly due to a higher base.
Trade deficit for January 2022 came in at USD 17.42 billion, with exports falling m-o-m to USD 34.50 billion. Manufacturing PMI rose to 54.9 as compared to 54.0 the previous month.
GST collections continue to remain robust with revenues for February 2022 at INR 1.33 trillion (higher by 18% y-o-y). This is the fifth instance where collections have been above INR 1.3 trillion.
GDP growth number for Q3 FY2022 came in lower than expected at 5.4%. For the full year, advance estimate for GDP growth number has been revised downwards from 9.2% to 8.9%.
OUTLOOK & STRATEGY
To address market worries about the demand-supply mismatch for G-Secs, RBI did not accept any bids in the 2026 and 2035 securities in the first weekly G-Sec auction of the month. The subsequent two weekly auctions were cancelled citing a high cash balance with the GOI. Additionally, the G-Sec switch auctions scheduled for February and March were also cancelled. A revised calendar for T-Bill auctions in March 2022 was announced, with the weekly auction amounts increased by INR 12,000 Crs.
In order to elongate the maturity profile of RBI’s forward book and smoothen the receivables relating to forward assets, RBI in a surprise move announced a USD/INR 2-year Sell Buy Swap auction worth USD 5 billion to be conducted on March 08, 2022. This can be viewed as another tool used by the RBI for sucking out surplus liquidity from the system. Whether this eventually results in RBI buying bonds through OMOs to absorb some of the supply due to the heavy Government borrowing expected in FY2023, will have to be seen.
Yields across the curve, which had shot up post the Budget announcement, saw a relief rally post the dovish MPC policy. However, pressure remained on longer end G-Sec due to rising Crude prices with the benchmark 10-year security moving higher during the month. With pick up in Bank CD issuances in the 1-year segment and higher borrowing through T-Bill auctions, money market rates in that segment have moved up by 5-10 bps.
Once the state elections are behind us, fuel price hikes along with a mix of tax cuts are inevitable given the move in oil prices over the past few months. Markets are clearly looking towards the central bank for some support, in an environment where oil prices are zooming up vertically, US Fed policy normalisation remains on course despite the risk-off environment and domestic inflation remains in uncomfortable territory.
For RBI, the coming months and quarters will be a testing time, in terms of balancing out its various mandates – managing the growth inflation tradeoffs, managing the government’s borrowing programme smoothly, and all this while still maintaining its hard-earned credibility. On our side - for now - we remain cautious in our positioning across our actively managed funds till further clarity emerges on the global front, oil prices and also RBI’s tolerance levels for yields before they come in to support the markets.
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