Nifty declined 3% in May’22 driven by weakened sentiment on the back of surging crude price, inflation worries and continued FII
selling. BSE Midcap index and BSE Smallcap indices declined sharply by 5.2% & 7.8%, respectively, reversing the outperformance of
last month versus the Nifty.
Global equities were flat in May’22 having digested some of the geopolitical pressures and hawkish stance of the Fed after a sharp 8% decline in April. Indian equities however declined sharply by 6% (US$ terms), under-performing the broader regional markets in May’22 (MSCI APxJ / EM: -1.0%/+1.0%).
Worldwide, most major indices saw flat to positive performance
with US S&P500 down 0.2% while Nikkei (1.6%), Hang Seng
(1.5%) and FTSE UK (1.0%) all registering gains. However,
geopolitical conflict continued to weigh on Euro Stoxx (-1.6%).
In sectoral trends, Metal was the major loser (-16%) driven by the imposition of government duties on steel exports. Power (-11%), Healthcare (-8%), Real Estate (-7%), Information Technology (-6%) and Oil & Gas (-5%) were other significant losers. Banking declined by 1.5% while FMCG was flat.
Auto (5%) was the only meaningful gainer as a decline in the steel and other commodity prices is expected to help auto earnings.
FIIs remained net sellers of Indian equities in May’22 (-$4.7 bn, following -$3.8 bn in March). This marked the 8th consecutive month of net equity outflows for FIIs, with YTD outflows of $22.1 bn. DIIs recorded inflows of $6.6 bn in May, maintaining the buying trend observed since March 2021.
Mutual funds and Insurance funds were both net buyers in May with $3.2 bn inflows and $3.4 bn inflows respectively.
India’s GDP growth slowed in Q4FY22 to 4.1%, reflecting the impact of the Omicron wave on manufacturing sector and contact-intensive services. For FY22, NSO pruned its GDP growth forecast to 8.7%, from 8.9%.
RBI in a surprise move hiked policy rates by 40 bps after having kept rates unchanged in the April MPC meet where it had raised inflation forecasts and lowered the growth outlook.
April’s CPI inflation rose to an 8-year high of 7.8% (YoY) up from 7.0% in March, reflecting a broad-based rise across food, fuel and core inflation (to 7.0% from 6.4%).
The Government of India also announced a range of measures to curb rising prices – cutting excise duty on petrol and diesel, imposing export duties on steel products and reducing import duties on coal and naphtha.
Industrial production (IP) growth rose to 1.9% (YoY) in March from a downwardly revised 1.5% in February.
Manufacturing PMI (54.7) and Services PMI (57.9) remained in the expansion zone in April, with Services PMI showing good improvement compared to its levels in the first quarter of the year, primarily due to the easing of Covid restrictions
India’s FX reserves came in at $598 bn. FX reserves have declined by US$2.9 bn in the last 4 weeks. The INR depreciated sharply over the month (down 1.6% MoM) and ended the month at 77.64/$ in May
Benchmark 10-year treasury yields averaged at 7.34% in May (26 bps higher vs. April avg.) and ended the month at 7.42% (up 28 bps MoM). Oil prices rose sharply (+15.9%) over May, after having been flat in April.
On the positive side, GST collections stood at Rs. 1.42 tn in March (15% YoY).
Higher global crude and commodity prices and the pass-through of higher input costs to consumers, along with supply chain bottlenecks in various sectors are likely to keep inflation at elevated levels. While Government and RBI are now focusing on containing inflation, a higher fiscal deficit due to duty cuts on petrol and diesel and higher subsidy for fertilizers is likely to lead to a further increase in government borrowing plan and has led to further strengthening of bond yields. This is likely to result in higher interest cost for other borrowers as well.
On the positive side, higher agri commodity prices along with a forecast of a normal monsoon are expected to lead to an improvement in rural demand. Higher government spending on infrastructure, partial shift of global supply chains away from China to India in certain sectors and measures like PLI (Production Linked Incentive) scheme are likely to domestic manufacturing growth over the medium term. We, therefore, continue to remain constructive on Indian equities going forward, despite near-term challenges.
Source: Bloomberg, MSCI
Monetary Policy Review – June 2022
The Monetary Policy Committee (MPC) came out with their bi-monthly policy statement today. Some of the key announcements are as follows:
• The MPC members unanimously voted to increase the policy repo rate under the Liquidity Adjustment Facility (LAF) by 50 bps to 4.90% with immediate effect
• Consequently, the standing deposit facility (SDF) rate was adjusted to 4.65% and the Marginal Standing Facility (MSF) rate and Bank Rate adjusted to 5.15%
• The MPC also unanimously decided to remain focused on the withdrawal of accommodation to ensure that inflation remained within the target going forward, while supporting growth
In light of the continuing geopolitical tensions between Russia and Ukraine, soaring energy and commodity prices and global supply chain disruptions, the MPC came out with revised growth and inflation outlook. Considering a base case assumption of a normal monsoon and an average crude price (Indian basket) of USD 105/bbl the projections have been mentioned below:
• Real GDP growth for FY2023 has been retained at 7.2% with the following quarterly projections: Q1 FY2023 at 16.2%, Q2 at 6.2%, Q3 at 4.1% and Q4 at 4.0%, with risks broadly balanced
• CPI projection for FY2023 has been revised upwards to 6.7% (from an earlier estimate of 5.7%) with the following quarterly projections: Q1 FY2023 at 7.5%, Q2 at 7.4%, Q3 at 6.2% and Q4 at 5.8%, with risks evenly balanced
Since the February policy, the CPI inflation outlook has been revised upwards by 220 bps and inflation is now expected to remain above the upper tolerance band of 6% through the first three quarters of FY2023. However, the Governor did mention that the projection of 6.7% does not account for the impact of today’s policy action. Additionally, the MPC has dropped the phrase “remain accommodative” from the stance and has only retained the term “withdrawal of accommodation”. The Governor also mentioned that the RBI remains focused on the orderly completion of the government’s borrowing programme and has all tools at its disposal to act when required.
In the absence of any CRR hike announcement and a rate hike of 50 bps broadly in line with market expectations, yields reacted positively to the MPC statement. The increase in CPI projection of 100 bps from the April policy does not include the impact of the hike conducted today. This hints that RBI does not want the markets to get a negative surprise on future inflation prints, given the status quo in market conditions.
Money market papers rallied by 10-15 bps post policy. Corporate bonds up to 3 years moved lower by around 10 bps. G-Sec in the 4-year segment also fell by 10 bps. Longer end G-Sec rallied by almost 10 bps post policy, however, levels corrected towards the end of the day with yields lower only by 2-3 bps d-o-d.
In the run-up to the MPC meeting, bond markets had already been discounting a fair bit of RBI hawkishness with yields having backed up meaningfully across segments. Hence, RBI’s 50 bps hike without a concomitant CRR hike, ended up having a calming effect on the markets – leading to some fall in yields post policy, especially at the short to medium end part of the curve.
In his statement as well as later in the press conference, the RBI Governor has been very careful to not give any forward guidance on the future path of interest rate trajectory – either in terms of the likely size of hikes over the coming few meetings or also in terms of the terminal rate. Rather, based on their FY2023 CPI forecast of 6.7% and the Q4 CPI forecast of 5.8%, markets have had to continue guesstimating the likely trajectory. With very high levels of uncertainty on the future trajectory of global parameters such as inflationary pressures in developed markets, likely direction of commodity prices especially oil and also domestic CPI movements over the coming few quarters, Governor Das has made RBI actions entirely data dependent, without any clear framework or guidelines to tie up their actions.
In our view, with Q4 CPI likely to have some upside risks to the RBI projection of 5.8%, we expect the terminal rates to be in the range of 6-6.5% over the course of the next year. That would imply a greater than zero real rate, which is essential from a macro-economic stability perspective and to ensure that savers are not disincentivised any further. Currently, the 2-4 year part of the curve is pricing at a higher terminal rate than this, and accordingly, we see good value in this segment for investors who are looking at a medium-term investment horizon. However, we remain cautious in our outlook on the longer end of the yield curve as that segment needs to become much more attractive (yields to move higher) to justify adequate relative value versus the 2-4 year space.
Debt Market Review – May 2022
The Federal Open Market Committee (FOMC) minutes published for the May meeting, indicated that the federal funds rate would most likely be increased by 50 bps each in the next two policy meetings. The minutes showed that the members were wary of the soaring inflation and would remain committed to address concerns on that front. The ongoing war between Russia and Ukraine and lockdowns in China would remain a key monitorable going forward.
The Personal Consumption Expenditures (PCE) price inflation projection was revised up and is now expected to be 4.3% in 2022 while falling thereafter to 2.5% in 2023. The minutes also indicated that the FOMC’s focus would remain to swiftly move the stance of the monetary policy towards neutral (through frontloading of rates and reduction in the Fed’s balance sheet) and from then to a restrictive policy stance depending on the incoming data on economic outlook and inflation. US CPI inflation for Apr 2022 came in at 8.3% (marginally lower than 8.5% in Mar 2022, although higher than consensus estimates). Core inflation also remained higher at 6.2%. The 10-year US Treasury yields traded in the 2.75% to 3.15% band during the month, and are currently trading a shade above 3.0%. Crude prices continued to remain elevated and traded in the USD 100/bbl to USD 120/bbl band during the month. Although OPEC+ agreed to increase oil output to stem the rising crude prices, Brent has continued to trade around USD 120/bbl.
Post the surprise inter-meeting rate hike by the MPC last month, yields have continued their sharp trajectory upwards, as expectations of frontloading of rate hikes are getting priced in.
On a month-on-month basis (as on May 31, 2022), money market rates have moved up by 90-110 bps and 2-3 year G-Sec and Corporate bonds are higher by 80-100 bps. Yields in the 5-10 year segment have also moved up by 30-60 bps. OIS levels have also seen a similar move.
The 10-year benchmark G-Sec yield closed at 7.42%, up by 28 bps from its previous close of 7.14% while that on the short-term 1-year bond ended 112 bps higher at 6.07%.
In the corporate bond segment, yields rose across the yield curve over the month. The 10-year AAA bond yield ended 42 bps higher at 7.75%, while the short-term 1-year AAA bond yield ended 115 bps up at 6.40%.
The spread between 1-year and 10-year AAA bond narrowed. Within the short-term segment, the yield on 3-month commercial paper (CP) was up 100 bps to 5.15% while the 1-year CP yield was up 125 bps at 6.40%.
On the domestic front, CPI inflation for Apr 2022 came in at a multi-year high (higher than expectations) of 7.79% (vs 6.95% in Mar 2022) due to higher food and fuel price inflation. Core CPI also edged higher to 7.0%. WPI inflation continued its upward trajectory clocking 15.08% in Apr 2022 (vs 14.55% in Mar 2022). Higher crude prices have continued to put pressure on inflation.
IIP for Mar 2022 remained sluggish at 1.9% (vs 1.7% in Feb 2022). Consumer durables and non-durables continued to remain in contraction. For the full year FY2022, IIP recorded an expansion of 11.3% y-o-y.
Trade deficit for Apr 2022 widened to USD 20.11 bn (vs USD 15.29 bn last year). Although exports have been robust, higher oil prices continue to put pressure on the import bill, resulting in markets now penciling in higher CAD estimates for FY2023.
PMI numbers have been encouraging with Manufacturing PMI at 54.6 and Services PMI at 58.9 in May 2022.
The GDP growth for Q4 FY2022 came in at 4.1% (in line with market expectations), taking the full year GDP growth for FY2022 to 8.7%. Fiscal deficit for FY2022 came in at 6.7% of GDP (slightly below the revised Budget estimate of 6.9%).
In an attempt to tackle inflationary pressures, Government of India (GOI) reduced excise duty on petrol and diesel by INR 8/liter and INR 6/liter respectively. Some of the states followed this up with cut in state taxes. The impact of the excise cut on inflation is estimated to be around 20-30 bps and the annual revenue loss to the Government is expected to be INR 1 Lakh Cr. However, the actual revenue deficit would be lower as the impact would be spread across 10 months and would only be incremental to the excise cut already factored in the Budget. RBI announced surplus transfer to the GOI to the tune of around INR 30,000 Crs (lower than budget estimates). The Government also announced the approval of additional spending on fertilizer subsidy to the tune of INR 1.1 Lakh Crs, taking the total possible outgo to INR 2.15 Lakh Crs. Subsequently, there was also news around the subsidy number being even higher. With disinvestments lagging and food subsidy also expected to be higher, fiscal pressures have once again come to the forefront. A higher nominal GDP might partly offset the shortfall, while a cut in capital expenditure also remains a lever with the Government. However, the evolving supply-demand dynamics will remain a key monitorable going forward.
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