Market may not slip into bear territory though possibility of near-term turmoil remains, says this CIO

The challenge being faced by India is striking the right balance between taming inflation and keeping the growth momentum intact. It’s very difficult to get both right. There are various underlying factors acting as a deterrent in getting these two dynamics at optimum levels. These are as follows:

Widening current account deficit (CAD): in the first quarter of the fiscal, the CAD widened to $23.9 billion (2.8 percent of GDP), mainly on account of a higher trade deficit. Certainly, things are challenging on the external front. That means India is going to be running a higher CAD this year.

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Currency volatility: the rupee has come under more and more fire because of the shooting power of the dollar. The RBI has drawn down heavily, circa $100 billion, with reserves at $545 billion from a peak of $642 billion a year ago. It continues to draw down to revive the rupee.

As and when the US Federal Reserve (the Fed) tightens its policy further, the USD will strengthen even more, which in turn will put additional pressure on the Rupee.

High debt-to-GDP ratio: India is currently running at a net debt-to-GDP ratio in excess of 80 percent. The government’s interest burden is more than 25 percent of revenues. Which means that the government is spending a significant proportion of its monies on debt servicing, which could have been better spent on capital or social expenditure.

Geopolitical issues: the prolonged Russia-Ukraine crisis as well as adverse developments in China-Taiwan can pose serious supply chain issues for the global economy, leading to supply disruptions and higher prices.

Shrinking export volumes: we have not seen the whole export story unfold. It has just about started. India's low tech and medium tech export volumes have been slowing since June, hitting the balance of payments (BoP) since August. That is a matter of great concern at this point of time.

After the 50 basis point (bps) repo rate hike, can more hikes be expected, as the Fed is likely to continue rate hikes well into 2023? What are the priorities of the RBI?

The key priorities would be controlling inflation control without compromising long-term growth, while maintaining a stable currency. Maintaining a balance between these three in the present volatile external and internal situation is a Herculean task.

The high frequency data for the second quarter indicates that economic activity remains resilient. Private consumption has been holding up and rural demand is also gaining traction, accompanied by a pick-up in credit offtake. Hence, the RBI should ensure that adequate liquidity is maintained in the banking system, and excess liquidity is withdrawn in an orderly manner.

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Unfortunately, there are upside risks to inflation by way of increase in cereal prices due to lower kharif production. Further, the delayed withdrawal of the monsoon and intense rain spells in various regions of the country have led to a rise in vegetable prices, which is a cause for concern, as admitted by the RBI Governor. While monetary policy cannot mitigate supply-related shocks, the central bank needs to be mindful of the risks it may face due to this.

Central banks across the world, led by the US Fed, have upped their hawkish tone and are ready to sacrifice growth to contain inflation. The RBI has made it clear that its monetary policy is driven by domestic inflation and growth considerations. It may not adopt extreme hawkish measures to control inflation jeopardising economic growth, which is showing some positive signs.

Hence, we could expect another 35 bps rate hike in the next meeting. The RBI may pause there unless there are adverse developments across the globe which compel it to act accordingly.

Do you think buying on dips is the best strategy now?

We subscribe to the view that buying on dips is the best strategy at all points of time, so long as the investor has a firm conviction backed by numbers that there is substantial potential for an upward movement in prices. Also, that the stock and the sector have a strong growth story, supported by strong financials, and run by a professionally committed management team and promoters.

Do you see a bear market for Indian equities if the US falls into recession the coming year?

The recent support provided by domestic institutional and retail investors in the recovery of the stock market post Covid gives us confidence that the market may not slip into bear territory. However, we can't ignore the fact any significant action by foreign institutional investors (FII) affecting inflows and outflows is bound to have a ripple effect in our stock market.

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Our economy is displaying resilience in the teeth of global turmoil, and a significant portion of our investee companies are domestic. Sure, there can be some turmoil in the near term — it would throw up some good buying opportunities.

Do you see a major risk to corporate earnings from the slowdown in global growth?

As our economy and markets aren’t insulated from global developments, there would be some direct and indirect effect on corporate earnings depending on their degree of exposure and dependence on foreign countries.

Softening crude prices due to a global recession would provide some comfort to certain sectors by lowering their raw material costs, but the same recession would also hit our exports, adversely impacting corporate earnings.

The supply chain will play a key role in determining the future earnings of some sectors. Apart from this, if inflation is unabated then a drop in consumption is inevitable, and may force the RBI to raise rates further. This in turn would have a cascading effect on the finance cost of the enterprise. Unless it is able to pass it on to customers, that would impact corporate earnings.

How do you view the RBI’s growth forecast for FY23-FY24, given the expected global slowdown?

The moderation of GDP growth numbers from 7.2 to 7 percent for FY23 is very realistic. As mentioned earlier, the global turmoil and higher inflation in the domestic market is bound to negatively impact our growth.

However it has raised the GDP growth forecast of Q1 FY24 from 6.7 to 7.2 percent. The RBI seems to have assumed that inflation and turmoil would have cooled in the future. As India is already the fastest growing economy, it would see a significant growth spurt in both domestic and international markets, justifying the upward revision in FY24 GDP growth estimates.

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