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Daily Voice | RBI may change policy stance and hike interest rates in mid 2022, says Unmesh Kulkarni of Julius Baer India

The Union Budget 2022-23 is likely to be a continuation of the ongoing drive of the Government to revive industry as well as all-round growth of the economy, post the couple of pandemic years that the country has had to live with.

December 27, 2021 / 11:56 AM IST
Unmesh Kulkarni, Managing Director-Senior Advisor, Julius Baer India.

Unmesh Kulkarni, Managing Director-Senior Advisor, Julius Baer India.

The RBI has already kick-started the withdrawal of liquidity from the money markets. Unmesh Kulkarni, Managing Director Senior Advisor at Julius Baer India says in the backdrop of rising global inflation (and interest rates) and persistently high core domestic inflation, the RBI is expected to hike interest rates in the coming year, as it is already behind the curve.

The IPO boom in 2021 is clearly an outcome of the underlying bullish investor sentiment for equities, given the sharp run up in the secondary markets, locally as well as globally. In 2022, "the IPO pipeline continues to be strong, and even the Government is looking at listing the Life Insurance Corporation of India (LIC) sometime in 2022, which would be yet another large issue," says Unmesh Kulkarni who has about 20 years of experience in the wealth management industry.

How do you sum up the year 2021 that priced in and saw several key events? What are the key events to watch out for in the year 2022?

2021 has been an eventful year for the markets and various asset classes in general. The Indian equity markets continued their strong recovery that commenced post the pandemic-driven fall of March 2020, on the back of sequential unlocking of various parts of the economy and a strong recovery in corporate earnings during the year. After the strong V-shaped recovery of 2020, the Nifty rallied a further 32 percent upto the recent peak made in October, before shedding some weight.

The buoyancy in the Indian equity markets also spread to the IPO market, as well as the unlisted market. This year has seen a record raise of IPOs so far (total Rs 1.4 trillion, YTD). The unlisted market has also seen a flurry of activity, with investors rushing in to acquire shares of Unicorns, through direct participation in unlisted equities as well as through private equity funds. India has added more than 40 unicorns this year, while we also saw a few of the unicorns getting listed this year, and many more expected to follow.


2021 has been a mixed year in terms of the coronavirus situation. The first half saw a Covid crisis in India and a few other emerging markets, while the situation improved significantly in India in the second half, but worsened in the developed markets, including US, UK and Europe. To add to the woes is the Omicron variant of the virus, which seems to be fast spreading through some countries and has rattled the equity markets in the past few weeks.

While the developed markets and India have performed very well this year, the regulatory issues in China that started around the middle of the year have rattled the Chinese equity indices and eroded the sentiment for the Emerging Markets basket, in general.

The current year has also seen oil prices and commodity prices soar significantly; WTI crude was up 70 percent+ this year, before correcting around 16 percent from its recent peak.

Unmesh Kulkarni

The centre-stage is being taken by the global inflationary trends across economies and the Fed tapering that commenced in November, which has added to the market's uncertainty over and above the Omicron scare.

The US Dollar, which was expected to weaken on the back of the global money printing and liquidity glut, has stood firm and actually appreciated; the Dollar index (DXY) is up 7.5 percent YTD. Gold and Silver lost some of their lustre this year, being down 5 percent and 15 percent respectively.

Going forward, 2022 is likely to present itself as a year of controlled optimism. The Indian economy will push forward on the recovery path, and the corporate earnings should also gain further momentum, leading to optimism about equities. However, there are some red flags that investors need to be keep a close eye on.

The progress of Omicron is obviously the immediate headwind, as it could potentially bring the much-dreaded third wave into the country, unless appropriately contained on time. Apart from that, the Fed tapering and the consequent impact on FPI flows (which have already been weak, of late) as well as the INR, will be factors to watch out for.

Indian equity markets were richly valued for some time, and the very recent correction needs to be monitored, as the markets have been held up by strong domestic investor flows rather than foreign investor participation.

Furthermore, the RBI has already kick-started the withdrawal of liquidity from the money markets, and in the backdrop of rising global inflation (and interest rates) and persistently high core domestic inflation, the RBI is expected to hike interest rates in the coming year, as it is already behind the curve.

2022 will therefore likely be a year of mixed fortunes, and investors may need to brace for some volatility after being handsomely rewarded since the last 18 months.

FIIs were net sellers in the year 2021, offloading more than Rs 80,000 crore worth of shares, but DIIs managed to offset loss by buying similar worth of shares during the year. What could be reasons for both sides (FIIs and DIIs) and will the FII continue to get impacted amid faster bond tapering and rising expectations for rate hikes in the US?

The rising interest rates in the US accompanied by a strong US Dollar (in the second half of this year) has slowed down the momentum of foreign investors in the domestic (secondary) equity markets. Besides, the China regulatory crackdown has led to a drop in the sentiment for emerging markets in general.

Indian equities have been trading at rich valuations for some time, which has led to some profit-taking by FPIs. However, although their activity has been subdued in the secondary market, FPIs have been big buyers in the IPO market, which has been robust this year, with a number of unicorns going for listing. The total FPI investment in IPOs in CY21 is expected to cross Rs 50,000 crore.

DIIs, on the other hand, have been big buyers of Indian equities. Indian Mutual Funds have witnessed record inflows from domestic investors, owing to the sharp improvement in sentiment on the back of the sustained rally in the markets, a steady increase in SIP flows as well as the lack of opportunities in fixed income. Besides mutual funds, direct investor participation in the equity markets has also been strong. Several Portfolio Management Schemes (PMS) have also been able to gather assets from investors, which has further added to the domestic participation in equities.

The Fed tapering and rising interest rates in the US do bring about some near-term uncertainties in terms of FPI flows. As seen from the previous tapering in 2013, emerging markets tend to experience some volatility when there is a sharp reversal of liquidity and interest rate policy by the Fed. However, the under-currents of the economic recovery and the earnings momentum are strong and likely to extend into the next few quarters. Any meaningful correction in the Indian markets emanating from the Fed action will make Indian equities relatively attractive for global investors, given the growth potential, ongoing reforms push of the government, a much healthier banking sector and the onset of revival of the investment cycle.

How do you sum up the primary market that saw fundraising of more than Rs 1.3 lakh crore in the year 2021? Do you expect a similar kind of fund raising in 2022 and can you name the companies that are planning IPOs in 2022?

This year has seen the highest ever raise of equity capital (Rs 1.4 trillion) through IPOs. More than 120 companies have raised capital from the IPO market this year, which is the third highest count in the last decade. This year also saw the highest number of companies raising more than Rs 5,000 crore each, from the primary market.

The IPO boom of this year is clearly an outcome of the underlying bullish investor sentiment for equities, given the sharp run up in the secondary markets, locally as well as globally. In a way, it also mirrors the IPO sentiment globally, which has been very strong this year.

The Indian IPO market has seen active participation this year by FPIs, especially the tech-driven companies. There has been a phenomenal surge in the tech start-ups going the listing way, with the regulator also making it easier for these companies to list their shares on the bourses.

The IPO pipeline continues to be strong in 2022, and even the Government is looking at listing the Life Insurance Corporation of India (LIC) sometime in 2022, which would be yet another large issue. However, the recent market correction of about 10 percent needs to be monitored, as a prolonged correction could slow down the momentum of fund raising from the primary market. The recent IPOs since November have seen some fatigue setting in amongst investors, which has resulted in lacklustre performance post listing. The S&P BSE IPO index reached an all-time high this year, towards the end of November, before correcting sharply by about 15 percent. Incrementally, it would be a bit challenging for the IPO markets to provide similar upside to investors as that witnessed in 2021, given the phenomenal run-up already in the markets, high valuations and the near-term headwinds staring in the face.

Companies will start reporting corporate earnings for the December quarter from January onwards. What are your broad expectations and do you expect Q3 to be much better than Q2 or is there any risk of higher commodity prices to numbers?

Earnings momentum of Indian corporates has picked up significantly, with revenues and profits (of Nifty companies) both up more than 30 percent, YoY. The banking sector, particularly private banks, has seen a steady improvement in loan growth as well recovery and upgrade in asset quality, the energy and metal sectors have benefited from the high commodity prices and volume growth, the IT sector is seeing a strong topline growth, whereas the consumer and retail sectors are getting a boost from the opening up of the economy. Management commentaries across the board suggest an improved demand environment, although the high energy and raw material prices are likely to put pressure on margins.

The earnings recovery should extend into the next couple of quarters, with a further pickup in demand on the back of a rejuvenating economy and revival of GDP growth. The Government's intent to re-ignite the investment cycle is likely to aid manufacturing, construction, capital goods and related sectors. The BFSI sector will also see an uptick in the backdrop of GDP growth picking up and an improvement in investment as well as consumer demand.

Having said that, there are two prominent risks for corporate earnings: (a) the elevated oil / commodity prices and other inflationary trends in the economy that will put pressure on operating margins through increased input prices, and its subsequent impact on demand in case this starts getting passed on to consumers, and (b) any significant deterioration of the coronavirus situation in the country (for instance, a third wave) that could put a spoke (though temporary) in the demand (especially rural demand which has been fragile recently) and the earnings recovery momentum.

The government has consistently been announcing several measures to lift the economic growth. Do you expect any significant announcement in the Union Budget 2022?

The Union Budget 2022-23 is likely to be a continuation of the ongoing drive of the Government to revive industry as well as all-round growth of the economy, post the couple of pandemic years that the country has had to live with.

As observed in recent years, most industry-level policy announcements are typically made by the Government outside the Budget, without really waiting for the Union Budget session. Having said that, the 2022-23 Budget is likely to see a continued push for the revival of the investment cycle, something that we saw as a focus area in the Union Budget 2021-22, with the announcements related to the National Infrastructure Pipeline.

Focus will also likely be on management of the fiscal deficit, given the fact that the Government's borrowing has scaled up significantly over the past couple of years. It is unlikely that there would be any relaxation in the taxation structure for individuals or corporates. The Government is likely to add more impetus to the disinvestment agenda, which it has already kicked off, as this becomes a bit critical for funding some of the ambitious long-term projects.

The Prime Minister, in a recent pre-Budget meeting with industry leaders, has laid down his vision for seeing Indian industries (in various sectors) among the top five in the world, and has assured that the government is committed to supporting the industries and taking initiatives that would give impetus to growth. Towards this, there may some sector-specific measures announced in the Budget, including for for the Small and Medium Enterprises (SME), which have been through some uncertainty during the pandemic. The Government also seems to be working on reducing unnecessary compliance burden for corporates.

Besides, as the Prime Minister suggested recently, the Government may invite the corporate sector to invest more in areas such as agriculture, food processing and natural farming.

What should investors learn from the year 2021 that has seen a strong rally, created several multi-baggers, higher commodity prices, and many more things?

One of the key learnings for investors is that they should view equity investment as a long-term growth opportunity. Indian equity markets have seen periods of under-performance, in absolute and relative terms, through the years 2015, 2016 as well as 2018 and 2019, followed by the flash crash of March 2020, but the strong bull run of 2020 and 2021 has more than made up for the earlier under-performance. It is important for investors to stay invested in equities, within their asset allocation, in order to reap the rewards in the bull runs.

For instance, despite the intermittent under-performance, the Nifty50 has still yielded an annualised return of about 16 percent since the past 3 years as well as 5 years. The broader market, including the mid/small caps have of course yielded superior returns over these periods.

It is equally important for investors to ensure that they align their portfolios over time to their strategic / core asset allocation, and not go too over-weight or under-weight equities, in order to ensure optimal performance in line with their risk-taking appetite. For instance, in the current times, when equity markets have yielded stellar returns, investors should review their asset allocation and re-align their portfolios to their strategic allocation by reducing any tactical over-weights that they might have built in the bull-run. At the same time, keeping in mind the long-term potential of the Indian economy and markets, investors should take advantage of any sharp correction of, say, 10-20 percent, to add to equities. However, it is essential to increase the holding period and have patience over the next couple of years, as it is unlikely that the stellar performance of April 2020 – October 2021 will be repeated in the near-term. Also, the focus should remain on the core underlying businesses of the companies and valuations, rather than just playing the momentum game.

Given the decisions taken by the Federal Reserve towards the end of 2021 amid inflationary pressures, do you think the RBI will also consider rate hikes in the year 2022? Also, what are your broad expectations from the RBI for the year 2022 including liquidity?

The US Federal Reserve has clearly shifted gears and is now looking to increase the pace of tapering, given the persistent inflationary trend. Besides, the Fed members are signaling about 3 rate hikes in 2022.

The inflationary trends are a problem not just for the US, but practically the entire world, with several nations in Europe and Asia (including emerging markets) also seeing their respective domestic inflation shore up substantially in the wake of liquidity pumping by central banks during the pandemic as well as strong rebound in demand post the initial lockdowns. The supply-shock induced sharp and prolonged run up in oil prices and commodity prices has further added to the inflation woes, especially for emerging markets.

India too has been witnessing the CPI at the higher end of its tolerance band, while the WPI has been reigning in double digits for some time and core inflation has been high and sticky as well.

The RBI has already embarked upon liquidity normalization by using the VRRR (variable rate reverse repo) auctions to suck out the excess liquidity from the money markets, and the pace as well as the quantum of normalization has been intensified in the recent weeks. The RBI has been behind the curve in terms of ‘rate normalisation’, given the fact that several emerging economies have already raised policy rates, and now developed economies are also seen slowly biting the bullet. As we step into 2022, the RBI will most likely continue initially with the liquidity normalization by hiking the reverse repo rate in the February policy review (which the markets are already factoring in) and changing its accommodative policy stance to neutral, followed by hiking the policy repo rate, starting from the middle of 2022. Through 2022 and 2023, we expect the RBI to gradually reverse the emergency rate cuts of the pandemic, and then calibrate further policy action to the evolving growth and inflation dynamics.

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Sunil Shankar Matkar
first published: Dec 27, 2021 07:50 am
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