By Shibani Kurian, Head- Equity Research and Fund Manager at Kotak Mahindra AMC
The Monetary Policy Committee (MPC) decided by 4:2 majority to keep the repo rate unchanged at 6.5 percent, in line with expectations. The MPC also decided by a majority of 4 out of 6 members to remain focused on withdrawal of accommodation to ensure that inflation aligns with the 4 percent target, while supporting growth. The RBI has clearly preferred to adopt a wait-and-watch approach and see how global conditions play out before reacting on policy rates in India.
The MPC noted that India’s growth remains strong in the global context and inflation is on a declining trajectory. Consequently, the real GDP growth projections for FY25 were maintained at 7.2 percent highlighting the resilience of the economy with India standing out as an oasis in the desert.
While the focus of RBI remains on bringing down the headline CPI inflation to 4 percent, its projections for CPI inflation currently stand at 4.5 percent for FY25. The RBI notes that there is a divergence between headline and core inflation trends with core inflation moderating to historic lows. On the other hand, the pace of moderation in headline inflation is uneven and slow. The target for the MPC is clearly the headline inflation where food inflation has a high share and hence, concerns surrounding it cannot be ignored. Food inflation contributed >75 percent to headline inflation in May/June.
At a systemic level, there has been an improvement in liquidity conditions. However, deposit growth continues to lag credit growth. So, the focus of banks would be on deposit accretion even as loan growth remains reasonably healthy. RBI states that banks must focus more on mobilisation of financial savings through innovative products. In this context, banks that have a higher share of retail deposits and CASA are better positioned.
The Fed funds future appears to be factoring in a rate cut cycle starting September. While the path to rate cuts in India by the RBI would likely follow the US Fed, global monetary policy cycle is not the only determinant of India’s rate cycle. RBI would likely keep in mind domestic growth and inflation along with any sharp changes in global demand conditions. In this context, one must note that the market has so far found it difficult to predict the trajectory of growth, inflation and rates in the US economy. Fed commentary too has ranged from inflation will remain elevated for a longer time, to now looking at cutting rates to support the economy. This shows how difficult it is to predict the US economy.
Our linkage to the US economy is limited in terms of growth and our domestic facing sectors remain well placed. Corporate earnings growth in the Q1FY25 earnings season have so far been largely in line with expectations, even though expectations in the current quarter were somewhat muted. However, the concern is valuations. While we have stable earnings growth, valuations are higher than what they have been, which could lead to near term volatility. Nifty valuations are at a 14 percent premium to its own history while mid and small caps are trading at 40-50 percent premium to their history. Typically, we have seen that mid and small caps have delivered better earnings than large caps in the last couple of years. Therefore, expectations are very elevated and earnings delivery becomes very important. We continue to believe that large caps and some of the larger midcaps are better placed in terms of risk reward compared to some of the small caps and microcaps. In terms of sectors, we believe that domestic facing sectors remain well placed while valuations are favourable in the case of sectors such as consumption and large cap technology players.
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