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Nifty jumped to almost 18K on FPIs buying support amid hawkish RBI and stable INR

RBI may hike another +75 bps minimum till Feb’23 (@25 bps) for a terminal rate +6.15% (if Fed goes for +150 bps rate hikes in rest of 2022)

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India’s benchmark stock index Nifty made a 4-month around 17992.20 Friday (19^th August), on positive U.S./global cues and FPIs buying support. Wall Street was boosted by signs of inflation easing, which may prompt the Fed for a +0.50% ‘normal’ rate hike in September, November, and December instead of ‘jumbo’ +0.75%. Dow Future also jumped on easing of China-Taiwan/U.S. geopolitical tensions as China almost withdraw from the war drill and President Xi reportedly sent a message to his U.S. counterpart Biden that this is not a time for a new crisis.

On Monday (22^nd August), the Nifty closed around 17490.70, lost almost -500 points from Friday’s high- in line with Dow Future amid hawkish Fed jawboning, slowing China (amid an impending drought despite targeted stimulus and commitment of coming out from zero COVID policy), surging inflation in Europe, and synchronized global stagflation.

Fed may hike another +150 bps minimum in September, November, and December to control inflation expectations contrary to earlier market expectations. Overall, July FOMC minutes and various Fed comments revealed that Fed is still quite concerned about elevated inflation, still substantially over Fed’s 2% target, but quite upbeat about U.S. economic activity and robust labor market despite some slowdown; i.e. Fed is still confident about a softish landing. Fed is also not ready to acknowledge even a technical recession of consecutive two-quarters of contraction. Fed is relying on a possible large positive revision for Q2CY22 GDP data. Thus Fed will continue with the faster tightening mode.

Fed also thinks that it’s not behind the inflation curve amid strong forward guidance in the past along with a current spate of faster tightening, the overall economy is slowing gradually, which will ultimately help to remove the present imbalance between elevated demand and constrained supply.

Now from Wall Street to Dalal Street, the Indian stock market was also boosted by increasing FII/FPIs buying. In the equity market, FPIs who have been huge net sellers in H1CY22; emerged as net buyers in July but their strongest buying is seen in the current month. From August 1-12, FPIs have pumped in a whopping Rs.22.453B -- making it their biggest investment this year. This also brings a remark of sustainability in FPIs' appetite for equities as market sentiments have turned bullish. This week alone, Indian benchmarks Sensex and Nifty 50 made the highest gains in four months.

Although the Indian market is now no longer FII dependent amid huge buying by DIIs, retail, HNI, and Prop desk-still FII buying is acting as a sentiment booster. FPIs turned sellers of Indian equities after an abrupt fall in INR against USD amid policy divergence between RBI and Fed. But FPIs began buying after USDINR reaches 80 levels, and RBI also fall in line with Fed and began to hike rates in line with Fed and other major G10 central banks. Generally, higher and volatile USDINR is negative for FPIs and thus stability of INR is a primary requirement for FPIs investment coupled with political and policy stability.

Indian market got a boost despite higher than expected rate hikes by RBI on 5^th August (+0.50% vs market expectations +0.35%)  as RBI is now following the Fed, which hiked +0.75% on 27^th July. This is protecting INR from an abrupt fall and boosts FPI's confidence. Looking ahead, if Fed goes for +0.50% rate hikes in September, November, and December instead of +0.75% due to signs of inflation easing, then RBI may also go for +0.25% rate hikes in September, December, and February; otherwise, expect +0.50% rate hikes by RBI if Fed goes for +0.75%.

As highly expected by this columnist, India’s central bank RBI hiked all policy rates by +0.50% on 5^th August against Fed’s +0.75% move on 27^th July.

Monetary Policy Statement, 2022-23 Resolution of the Monetary Policy Committee (MPC) August 3-5, 2022

https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=54148

On the basis of an assessment of the current and evolving macroeconomic situation, the Monetary Policy Committee (MPC) at its meeting today (August 5, 2022) decided to:

Increase the policy repo rate under the liquidity adjustment facility (LAF) by 50 basis points to 5.40 percent with immediate effect.

Consequently, the standing deposit facility (SDF) rate stands adjusted to 5.15 percent and the marginal standing facility (MSF) rate and the Bank Rate to 5.65 percent.

The MPC also decided to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.

These decisions are in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 percent within a band of +/- 2 percent while supporting growth.

The main considerations underlying the decision are set out in the statement below.

Assessment

Global Economy

Since the MPC’s meeting in June 2022, the global economic and financial environment has deteriorated with the combined impact of monetary policy tightening across the world and the persisting war in Europe heightening the risks of a recession. Gripped by risk aversion, global financial markets have experienced surges of volatility and large sell-offs. The US dollar index soared to a two-decade high in July. Both advanced economies (AEs) and emerging market economies (EMEs) witnessed the weakening of their currencies against the US dollar. EMEs are experiencing capital outflows and reserve losses which are exacerbating risks to their growth and financial stability.

Domestic Economy

Domestic economic activity remains resilient. As of August 4, 2022, the southwest monsoon rainfall was 6 percent above the long period average (LPA). Kharif sowing is picking up. High-frequency indicators of activity in the industrial and services sectors are holding up. Urban demand is strengthening while rural demand is gradually catching up. Merchandise exports recorded a growth of 24.5 percent during April-June 2022, with some moderation in July. Non-oil and non-gold imports were robust, indicating strengthening domestic demand.

CPI inflation eased to 7.0 percent (year-on-year, y-o-y) during May-June 2022 from 7.8 percent in April, although it persists above the upper tolerance band. Food inflation has registered some moderation, especially with the softening of edible oil prices, and deepening deflation in pulses and eggs. Fuel inflation moved back to double digits in June primarily due to the rise in LPG and kerosene prices. While core inflation (i.e., CPI excluding food and fuel) moderated in May-June due to the full direct impact of the cut in excise duties on petrol and diesel pump prices, effected on May 22, 2022, it remains at elevated levels.

Overall system liquidity continues in surplus, with average daily absorption under the LAF at ₹3.8 lakh crore during June-July. Money supply (M3) and bank credit from commercial banks rose (y-o-y) by 7.9 percent and 14.0 percent, respectively, as of July 15, 2022. India’s foreign exchange reserves were placed at US$ 573.9 billion as of July 29, 2022.

Outlook

Spillovers from geopolitical shocks are imparting considerable uncertainty to the inflation trajectory. More recently, food and metal prices have come off their peaks. International crude oil prices have eased in recent weeks but remain elevated and volatile on supply concerns even as the global demand outlook is weakening. The appreciation of the US dollar can feed into imported inflation pressures. Rising Kharif sowing augurs well for the domestic food price outlook. The shortfall in paddy sowing, however, needs to be watched closely, although stocks of rice are well above the buffer norms.

Firms polled in the Reserve Bank’s enterprise surveys expect input cost pressures to soften across sectors in H2. Cost pressures are, however, expected to get increasingly transmitted to output prices across manufacturing and services sectors. Taking into account these factors and on the assumption of a normal monsoon in 2022 and an average crude oil price (Indian basket) of US$ 105 per barrel, the inflation projection is retained at 6.7 percent in 2022-23, with Q2 at 7.1 percent; Q3 at 6.4 percent; and Q4 at 5.8 percent, and risks evenly balanced. CPI inflation for Q1:2023-24 is projected at 5.0 percent.

On the growth outlook, rural consumption is expected to benefit from the brightening agricultural prospects. The demand for contact-intensive services and the improvement in business and consumer sentiment should bolster discretionary spending and urban consumption. Investment activity is expected to get support from the government’s capex push, improving bank credit and rising capacity utilization. Firms polled in the Reserve Bank’s industrial outlook survey expect sequential expansion in production volumes and new orders in Q2:2022-23, which is likely to sustain through Q4.

On the other hand, elevated risks emanating from protracted geopolitical tensions, the upsurge in global financial market volatility, and tightening global financial conditions continue to weigh heavily on the outlook. Taking all these factors into consideration, the real GDP growth projection for 2022-23 is retained at 7.2 percent, with Q1 at 16.2 percent; Q2 at 6.2 percent; Q3 at 4.1 percent; and Q4 at 4.0 percent, and risks broadly balanced. Real GDP growth for Q1:2023-24 is projected at 6.7 percent.

Headline inflation has recently flattened and the supply outlook is improving, helped by some easing of global supply constraints. The MPC, however, noted that inflation is projected to remain above the upper tolerance level of 6 percent through the first three quarters of 2022-23, entailing the risk of destabilizing inflation expectations and triggering second-round effects.

Given the elevated level of inflation and resilience in domestic economic activity, the MPC took the view that further calibrated monetary policy action is needed to contain inflationary pressures, pull back headline inflation within the tolerance band closer to the target, and keep inflation expectations anchored to ensure that growth is sustained. Accordingly, the MPC decided to increase the policy repo rate by 50 basis points to 5.40 per cent. The MPC also decided to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.

All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra, and Shri Shaktikanta Das – unanimously voted to increase the policy repo rate by 50 basis points to 5.40 percent. All members - Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra, and Shri Shaktikanta Das, except Prof. Jayanth R. Varma - voted to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth. Prof. Jayanth R. Varma expressed reservations about this part of the resolution.

RBI Governor Das’s prepared statement:

https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=54150

We will celebrate 75 years of our Independence in another ten days. It is a great moment for all of us. I take this opportunity to convey my warm greetings to everyone on this historic occasion.

Successive shocks to the global economy are taking their toll in terms of globalized inflationary surges, tightening of financial conditions, sharp appreciation of the US dollar, and lower growth across geographies. Multilateral institutions, including the International Monetary Fund (IMF), have revised global growth projections downwards and highlighted the rising risks of a recession. Disquietingly, the globalization of inflation is coinciding with the delocalization of trade. The pandemic and the war have ignited tendencies towards greater fragmentation, reshoring of supply chains and retrenchment of capital flows, which will pose long-term challenges for both globalization and the global economy.

For emerging market economies (EMEs), these risks are magnified as they have to contend with both domestic growth-inflation trade-offs and spillovers from the most synchronized tightening of monetary policy worldwide. EMEs are facing a rapid tightening of external financial conditions, capital outflows, currency depreciations, and reserve losses simultaneously. Some of them are also facing mounting burdens of debt and default. Elevated food and energy prices and shortages are rendering their populations vulnerable to the insecurity of livelihood.

The Indian economy has naturally been impacted by the global economic situation. We have been grappling with the problem of high inflation. Financial markets have remained uneasy despite intermittent corrections. We have witnessed large portfolio outflows to the tune of US$ 13.3 billion during the current financial year so far (up to August 3). Nevertheless, with strong and resilient fundamentals, India is expected to be amongst the fastest growing economies during 2022-23 according to the IMF, with signs of inflation moderating over the course of the year.

Export of goods and services together with remittances are expected to keep the current account deficit within sustainable limits. The decline in external debt to GDP ratio, net international investment position to GDP ratio, and debt service ratio during 2021-22 impart resilience against external shocks. The financial sector is well capitalized and sound. India’s foreign exchange reserves, supplemented by net forward assets, provide insurance against global spillovers. Our umbrella remains strong.

Decisions and Deliberations of the Monetary Policy Committee (MPC)

Against this background, the monetary policy committee (MPC) met from August 3 to 5 and reviewed the macroeconomic situation and its outlook. The MPC decided unanimously to increase the policy repo rate by 50 basis points to 5.4 percent, with immediate effect. Consequently, the standing deposit facility (SDF) rate stands adjusted to 5.15 percent; the marginal standing facility (MSF) rate, and the Bank Rate to 5.65 percent. The MPC also decided to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.

Let me now dwell briefly on the MPC’s rationale for its decisions on the policy rate and the stance. Against the prevailing adverse global environment, the MPC noted that domestic economic activity is resilient and progressing broadly along the lines of the June resolution of the MPC. Consumer price inflation has eased from its surge in April but remains uncomfortably high and above the upper threshold of the target. Inflationary pressures are broad-based and core inflation remains at elevated levels. The volatility in global financial markets is impinging upon domestic financial markets, including the currency market, thereby leading to imported inflation.

With inflation expected to remain above the upper threshold in Q2 and Q3, the MPC stressed that sustained high inflation could destabilize inflation expectations and harm growth in the medium term. The MPC, therefore, judged that further calibrated withdrawal of monetary accommodation is warranted to keep inflation expectations anchored and contain the second-round effects. Accordingly, the MPC decided to increase the policy repo rate by 50 basis points to 5.4 percent. The MPC also decided to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.

Assessment of Growth and Inflation

Growth

Domestic economic activity is exhibiting signs of broadening. The southwest monsoon rainfall and reservoir levels are above normal; Kharif sowing is progressing well, although it is marginally below last year’s level due to uneven rainfall distribution. On the demand side, indicators such as the production of consumer durables, domestic air passenger traffic, and the sale of passenger vehicles suggest improvement in urban demand. Rural demand indicators, however, exhibited mixed signals – while two-wheeler sales increased, tractor sales contracted in June over a high base though.

High-frequency indicators of the services sector like railway freight traffic, port freight traffic, e-way bills, toll collections, and commercial vehicle sales remained robust in June and July. Investment activity is also picking up – the production of capital goods recorded double-digit growth for the second month in a row in May and the import of capital goods also witnessed robust growth in June. PMI manufacturing rose to an 8-month high in July. PMI services indicated continued expansion in July, although it fell from an over 11-year high of June.

Capacity utilization in the manufacturing sector is now above its long-run average, signaling the need for fresh investment activity in additional capacity creation. Bank credit growth has accelerated to 14.0 percent (y-o-y) as of July 15, 2022, from 5.4 percent a year ago. Incoming data of corporates for Q1 indicate that sales and demand conditions and profitability of the manufacturing sector remained buoyant.

Looking ahead, good progress of the southwest monsoon and Kharif sowing would support rural consumption. Urban consumption is expected to benefit from the demand for contact-intensive services, better performance of corporates, and improving consumer optimism. The increase in capacity utilization, the government’s capex push, and large expansion in bank credit should support investment activity.

According to our survey, manufacturing firms expect sustained improvement in production volumes and new orders in Q2:2022-23, which is likely to sustain through Q4. At the same time, the domestic economy faces headwinds from global forces - protracted geopolitical tensions; rising global financial market volatility; tightening global financial conditions; and global recession risks.

Taking all these factors into consideration, the real GDP growth projection for 2022-23 is retained at 7.2 percent, with Q1 at 16.2 percent; Q2 at 6.2 percent; Q3 at 4.1 percent; and Q4 at 4.0 percent, with risks, broadly balanced. Real GDP growth for Q1:2023-24 is projected at 6.7 percent.

Inflation

June 2022 was the sixth consecutive month when headline CPI inflation remained at or above the upper tolerance level of 6 percent. Looking ahead, the inflation trajectory continues to be heavily contingent upon the evolving geopolitical developments, international commodity market dynamics, global financial market developments and the spatial and temporal distribution of the southwest monsoon.

Since the last MPC meeting, however, there has been some let-up in global commodity prices – particularly in prices of industrial metals – and some softening in global food prices. Domestic edible oil prices are expected to soften further on the back of improving supplies from key producing countries and the Government’s supply-side interventions. The resumption of wheat supply from the Black Sea region, if sustains, could help temper international prices.

Supply chain pressures, though elevated, are on an easing trajectory. Further, the advance of the southwest monsoon is by and large on track, and Kharif sowing has picked up in recent weeks. The shortfall in Kharif sowing of paddy, however, needs to be watched closely, although buffer stocks are quite large. Household inflation expectations have eased, but they remain elevated.

Incidence of unseasonal and excessive rainfall, if any, can impact food prices, especially vegetable prices. Greater transmission of input cost pressures to selling prices across manufacturing and services sectors may also create fresh price pressures. Moreover, the persistently elevated cost of living conditions could translate to higher wages and further price increases, especially if the pricing power of firms strengthens.

Taking into account these factors, and on the assumption of a normal monsoon in 2022 and an average crude oil price (Indian basket) of US$ 105 per barrel, inflation is projected at 6.7 percent in 2022-23, with Q2 at 7.1 percent; Q3 at 6.4 percent; and Q4 at 5.8 percent, with risks evenly balanced. CPI inflation for Q1:2023-24 is projected at 5.0 percent.

The inflation trajectory is now poised at a decisive point. While there are incipient signs of a confluence of factors that could lead to further softening of domestic inflationary pressures, there remain significant uncertainties. In such a milieu, with growth momentum expected to be resilient despite headwinds from the external sector, monetary policy should persevere further in its stance of withdrawal of accommodation to ensure that inflation moves close to the target of 4.0 percent over the medium term while supporting growth. A calibrated approach would provide sufficient flexibility to monetary policy in the current uncertain environment.

Liquidity and Financial Market Conditions

The introduction of the standing deposit facility (SDF) in April 2022, which raised the floor of the liquidity adjustment facility (LAF) corridor by 40 basis points (bps), along with the policy repo rate hikes of May and June, have effectively resulted in the withdrawal of accommodation by 130 bps. Consequently, the weighted average call rate (WACR) – the operating target of monetary policy – has commensurately firmed up.

At the longer end of the money market, interest rates on 91-day treasury bills, commercial paper (CPs), and certificates of deposit (CDs) have also moved higher since April. The rate hikes also triggered an upward adjustment in the benchmark lending rates by the banks. Term deposit rates are also increasing which should bode well for the availability of funds with the banks in the context of sustained buoyancy in credit demand.

Surplus liquidity in the banking system, as reflected in average daily absorptions under the LAF (both SDF and variable rate reverse repo auctions), moderated to ₹3.8 lakh crore during June-July 2022 from ₹6.7 lakh crore during April-May. The sharp moderation in surplus liquidity from July 20, mainly on account of tax and capital outflows, resulted in money market rates firming up above the repo rate.

To alleviate the liquidity stress, the RBI conducted a variable rate repo auction of ₹50,000 crores of 3 days maturity on July 26, 2022. Going forward, and as indicated in my February 2022 statement, the RBI will remain vigilant on the liquidity front and conduct two-way fine-tuning operations as and when warranted – both variable rate repo (VRR) and variable rate reverse repo (VRRR) operations of different tenors, depending on the evolving liquidity and financial conditions.

During the current financial year (up to August 4), the US dollar index (DXY) has appreciated by 8.0 percent against a basket of major currencies. In this milieu, the Indian Rupee has moved in a relatively orderly fashion depreciating by 4.7 percent against the US dollar during the same period – faring much better than several reserve currencies as well as many of its EME and Asian peers.

The depreciation of the Indian rupee is more on account of the appreciation of the US dollar rather than weakness in macroeconomic fundamentals of the Indian economy. Market interventions by the RBI have helped in containing volatility and ensuring the orderly movement of the rupee. We remain watchful and focused on maintaining the stability of the Indian rupee.

The Indian financial system remains resilient. This will help the economy in emerging out of the shadows of the pandemic and the impact of the war in Europe. While the banking system remains well capitalized and profitable, a deleveraged corporate sector augurs well for sustaining the recovery.

External Sector

India’s external sector has weathered the storm while navigating through the recent global spillovers. Merchandise exports grew in April-July 2022 while merchandise imports surged to a record high on the back of elevated global commodity prices. Consequently, the merchandise trade deficit expanded to US$ 100.0 billion in April-July 2022. Provisional data indicate that demand for services exports, especially IT services, remained buoyant in Q1 despite global uncertainty. Exports of travel and transport services also improved in Q1:2022-23 on a year-on-year basis.

From the external financing perspective, net foreign direct investment (FDI) at US$ 13.6 billion in Q1:2022-23 was robust as compared to US$ 11.6 billion in Q1:2021-22. Foreign portfolio investment, after remaining in exit mode during Q1:2022-23, turned positive in July 2022. Along with several other measures undertaken in July, the Reserve Bank has also used its foreign exchange reserves accumulated over the years to curb volatility in the exchange rate. Despite the resultant drawdown, India’s foreign exchange reserves remain the fourth largest globally.

Concluding Observations

The Indian economy is holding steady and progressing in an ocean of turbulence and uncertainty. As we celebrate Azadi ka Amrit Mahotsav, this is a moment of reckoning, reflection, and renewed resolve to work for the betterment of our economy. We, in the RBI, reiterate our commitment to maintaining price and financial stability to place our economy on a sustainable path of growth. Our actions have helped the economy to tide over a series of shocks in the last two and half years. We are seized of our role at this critical juncture and will persevere in our efforts to ensure a safe and soft landing. This is a moment to recall a quote from Mahatma Gandhi: “For me, the road to salvation lies through incessant toil in the service of my country and there through of humanity”.

 

Highlights of RBI monetary policy: 5^th August’22

·         Hikes all policy rates by +0.50% against market expectations +0.35%

·         Cautious about the stagflation-like situation on both sides of the Atlantic (U.S.-Europe) amid lingering geopolitical tensions between Russia-Ukraine/NATO, subsequent economic sanctions, supply chain disruptions, higher inflation, and faster central bank tightening

·         Domestic economic activity remains resilient

·         Inflation (CPI) remains elevated above the 6% upper tolerance level, although eased from +7.8% in April to around +7.0% in May-June

·         Although core inflation eased to some extent, it also remains sticky at elevated levels

·         Overall system (money market) liquidity remains surplus

·         M3 growth was +7.9%, while credit growth was +14.0% (June-July)

·         Projected average inflation for FY23 at around +7.2% and +5.0% for Q1FY24 (unchanged from June estimate)

·         Projected average GDP growth for FY23 at +7.2% in FY23 and +6.7% in FY24 (unchanged from June estimate)

·         Although headline inflation (CPI) recently flattened amid some easing of global & local supply constraints and government intervention, inflation is still projected to be above the +6.0% upper tolerance level through the rest of FY23, which may further destabilize inflation expectations, triggering 2^nd round effects

·         As domestic economic activity is still resilient (robust), but inflation is elevated and still substantially above the 4% target, RBI goes for another calibrated rate hike of +0.50% to contain demand and inflation thereof

·         Looking ahead, RBI will also remain focused on the withdrawal of accommodation; i.e. calibrated tightening (rate hikes) so that headline CPI falls back closer to the 4% target while supporting growth

·         Like Fed, RBI is also looking for a softish landing; i.e. calibrated tightening to bring down inflation back to target without causing an all-out recession

Highlights of RBI Governor’s statement: 5^th August’22

·         Synchronized global stagflation, tightening of financial conditions, sharp appreciation of USD, and globalization of inflation are now major headwinds

·         The Russia-Ukraine war and COVID pandemic caused a major fragmentation of the world geopolitically and subsequent supply chain disruptions are now posing long-term challenges for both globalization and the global economy

·         Most of the EMEs are now facing huge risks of stagflation, rapid tightening of external financial conditions, capital outflows, local currency depreciation against USD, and FX reserve losses coupled with a huge burden of external debts and even risks of defaults

·         India as a part & parcel of EME and the global economy is also facing various headwinds in the form of higher imported inflation and large portfolio outflows

·         But Indian economy is also projected to be among the fastest growing economies in FY22-23

·         Early signs of moderation in inflation for India

·         Robust export of goods and services along with resilient remittances are expected to keep CAD within sustainable limits

·         Negligible external debt and net FDI inflows impart resilience against external shocks

·         India’s financial sector is well capitalized and sound

·         India’s corporate sector is now largely deleveraged

·         Comfortable FX reserve supplemented by net forward assets providing against global spillovers

·         India’s rainy day umbrella remains strong

·         As the Indian economy remains resilient (robust), but both headline and core inflation remains elevated and still substantially above the target of +4.0%, RBI goes for another rate hike of +0.50% to bring down inflation

·         Higher USDINR will cause more imported inflation- RBI rate hike action will keep USDINR as well as imported inflation stable

·         Looking ahead, as inflation is expected to be above the +6.0% upper tolerance band of RBI, while GDP growth is expected to be robust, RBI will continue its calibrated rate hike action to bring inflation expectations under and also inflation closer to the target of +4.0%, while supporting economic growth

·         Most of the economic indicators including high-frequency ones are showing a robust Indian economy, firing on all cylinders

·         Early signs of inflation moderation amid some easing of global supply chain constraints and local supply chain interventions by the government

·         But inflation risk remains to the upside because of global spillovers including lingering geopolitical tensions between Russia/China with Ukraine/NATO

·         RBI will remain vigilant on the liquidity front and conduct two-way fine-tuning operations as and when warranted – both variable rate repo (VRR) and variable rate reverse repo (VRRR) operations of different tenors, depending on the evolving liquidity and financial conditions; i.e. RBI is both injecting and absorbing liquidity as and when required

·         INR is outperforming may reserve (AE) and EM currency against sharply appreciating USD

·         The depreciation of the Indian rupee is more on account of the appreciation of the US dollar rather than weakness in macroeconomic fundamentals of the Indian economy

·         Market interventions by the RBI have helped in containing volatility and ensuring the orderly movement of the rupee

·         RBI remains watchful and focused on maintaining the stability of the Indian rupee

·         RBI will ensure a safe and soft landing while ensuring price and financial stability; RBI will ensure inflation falls back closer to the target of +4.0% by calibrated tightening without causing an all-out recession

Highlights of RBI Governor Das’s Presser statement and comments for Q&A session: 5^th August’22

·         First, in an ocean of high turbulence and uncertainty, the Indian economy is an island of macroeconomic and financial stability. The economic growth is resilient. Now all these, that is financial stability, macroeconomic stability, and resilience of growth are possible despite two black swan events happening one after the other and multiple shocks. That's the first takeaway from whatever we have said

·         Second, at this point in time, there are signs that CPI inflation has peaked, and it is expected to moderate going into the fourth quarter of this year and the first quarter of next year. We have presented this in the MPC statement and the resolution also. But inflation remains at unacceptably high levels, and there are also several uncertainties which are clouding the outlook. Therefore, monetary policy has to act, and that is why the monetary policy action of a 50 basis points rate hike was announced today, a unanimous resolution of the MPC

·         The third point is that if you put together the first two points, what emerges is those steps that have to be taken to contain inflation and inflation expectations. The other thing that comes out is that resilient economic activity gives us the space to act. The aspect of growth is always taken into consideration and is always factored in, in MPCs deliberations as well as in MPC’s decisions

·         The fourth point I would like to mention as a part of the broad picture is that the excess liquidity which we had, is being gradually brought down. I have mentioned it in the resolution. We have also said that there will be two-way fine-tuning operations with regard to liquidity based on the evolving situation to ensure that there is adequate liquidity in the system

·         The fifth point is that with regard to the external sector, the current account deficit is expected to remain within manageable limits. The Reserve Bank has the ability to finance the current account deficit based on our assessment. The Forex reserves remain strong, and the Reserve Bank will effectively deal with excess volatility of the exchange rate, and as I mentioned in the statement, the umbrella remains strong

·         The sixth and final point is that monetary policy will be calibrated, measured, and nimble depending on the unfolding dynamics of inflation and economic activity. The focus will remain on ensuring a safe and soft landing for the economy. As I added as a part of my statement, it is once again whatever approach it takes for the RBI going into the third year. We had it in the first year of the pandemic, the second year of the pandemic, and also now given the challenges and uncertainties that we are confronted with

·         Successive sharp rate hikes by RBI are to contain inflation as it’s at unacceptably high levels despite some recent easing

·         “Inflation remains at seven percent, i.e., unacceptably high levels. Even according to our projections, they remain above six percent for the first three quarters of the current year; the fourth quarter projection is 5.8 percent. With that kind of inflation trajectory, obviously, monetary policy has to act.”

·         +50 bps rate hikes now become a new normal by major global central banks

·         “With regard to the repo rate actions that we have taken, if you see it from a comparative perspective, although our decisions are primarily driven by our domestic factors. If you look at other central banks, today 50 basis points have become the new normal. A number of central banks are now hiking by 75 to 100 basis points. There is a tendency that 75 to 100 basis points rate hike will perhaps take over 50 basis points.”

·         “In the Reserve Bank, we take a very calibrated and measured view; we factor in the impact of the rate action on the aspect of growth. So, the aspect of growth and the aspect of a rate hike on our demand, overall consumer demand, and urban and rural demand has been factored in. Based on that, and prevailing and expected inflation growth dynamics; we have taken a balanced call.”

·         RBI inflation projections have factored in the past two rate hikes and also the current August hike

·         Overall liquidity conditions remain comfortable and banks are also embarking on very aggressive deposit mobilization schemes

·         Banks have to take care of higher credit growths through higher deposits rather than depending on RBI funds perennially; almost all banks are now offering higher deposit rates for higher deposits along with higher lending rates

·         RBI is ensuring two-way repo operations to ensure adequate liquidity as per the evolving situation

·         RBI will ensure orderly movement/stability in INR for controlled imported inflation

·         Presently CAD remains at sustainable and manageable levels

·         Presently RBI repo rate is at real negative levels, which is a matter of concern for RBI and the MPC is attentive to it

·          “With regard to negative interest rates, yes negative interest rates are a matter of concern and that is something which engages the attention of the MPC during its discussions and also internally in the Reserve Bank”

·         Presently RBI is not in a position to provide Fed like dot-plots (forward guidance) about the terminal rate or any real positive rate levels because of volatile geopolitics and global economics

·         “That is something which I cannot spell out because it will depend on the evolving dynamics. There are two aspects to it one is our primary target of bringing down inflation closer to the target and factoring in the aspect of growth and international uncertainties and developments. The exact approach whether we will front load or we will space out is for you to assess. The MPC will take measured and calibrated action depending on the evolving situation. Beyond that, it will not be possible for me to provide a roadmap of how we are going to do. Perhaps, you are referring to the kind of dot plot that the US adopts. But in the uncertain environment that we are living in today, the dot plot itself will have to be revised every fortnight.”

·         Deputy RBI Governor Patra: “When we were in the pandemic mode, there was only one thing that was moving that was inflation was high, and the policy rate was low. Now we have two moving parts, one is the policy rate is rising, and inflation is likely to fall. So, anything can happen. Now there are two moving parts. It might be sooner or it might be later.”

·         CAD may reduce going forward as petro product export will go higher after reduction of export duty, while import bill could come down because of moderation in global crude oil prices recently

·         Deputy RBI Governor Patra: “The CAD for the year as a whole cannot be assessed on the basis of one month’s trade deficit. You have just got May and June which were high. Let me tell you some facts about the trade deficit. First of all, the small decline in exports is because petroleum product exports have slowed down. Now the government has immediately responded by reducing the export tax, and also the windfall tax. And we expect that it will be back on stream in a month's time because this reduction of duty has been a sizable Number. Secondly, in the imports, the average price of oil, which we announced in the MPC was US$105 per barrel. But today it is trading at US$94 per barrel. All commodity prices are easing. So, we expect a lot of relief on the import front.

·         RBI is quite confident about CAD financing amid robust FDI, reversal of FPI portfolio outflows, and resilient remittances

·         “Now, what is the thing about the current account deficit, it's not the size that matters. Is it financeable or is it not? Now FDI is higher than last year. Portfolio flows have started coming back in a big way. On August 1st we got portfolio inflows of the amount equal to the whole of July. Trade credits are strong. ECBs, we have enhanced opportunities for accessing it, and NRI deposits are also being regularized. So, I think it's eminently financeable.”

·         China-Taiwan/US war of words is not a black swan event till now and India should be affected minimally in any way  

·         “You are referring to what's happening in Taiwan probably. It will be extremely premature to call it a Black Swan event because we are just two or three days into it. But so far as India is concerned, our trade with Taiwan is minuscule. It's about 0.7 percent of our total trade. So, the impact on India will be very negligible. The capital flows in terms of FDI and others are also very low. So, India is not going to be impacted with regard to what's happening or what is likely to happen in Taiwan.”

·         India is not decoupled from the rest of the world in terms of spillover effects of various geopolitical and COVID crises, alt5hpugh may be less affected compared to some of its EM peers

·         Discussion about neutral stance levels of monetary policy (rates) among MPC members will be reflected in the MPC minutes

·         RBI sees the present phase of elevated domestic inflation as a result of global supply chain disruptions and higher demand because of the huge COVID fiscal stimulus in many AEs

·         Indian elevated inflation is largely higher than imported inflation

·          “So far the current inflation is concerned; the demand-pull is not a significant factor. It's primarily due to various supply chain issues and various international developments, and because of imported inflation. India did not inject the kind of liquidity and other kinds of stimulus support, which many other countries, especially advanced countries provided to their economies which has resulted in a lot of demand pressure and that has fueled inflation.”

·         RBI does not think domestic inflation is a result of higher domestic demand and monetary/fiscal stimulus

·         RBI is not sure about what levels of the rate hike will pause

·         “So, far as India is concerned, the monetary policy actions did not fuel inflation. That is the position that comes out of our analysis, as of now. It's happening essentially because of supply chain and international factors. Regarding pause, it’s very difficult to say at what level we will pause because the situation is very dynamic and extremely uncertain”.

·         RBI will allow orderly movement in USDINR, with minimum daily volatility; i.e. RBI may allow orderly appreciation or depreciation of INR as per global movement in USD

·         RBI will not provide any future guidance about rate path or neutral/restrictive rate levels

·         “It will not be possible to provide future guidance on policy. When we are on a rate-cutting cycle it is easier to provide forward guidance. But when we are on a cycle of rate hikes and given the level of uncertainty, I would not venture to provide future guidance about the rate actions. The future guidance is essentially withdrawal of accommodation and we want to control inflation. You have to draw up your own derivatives from that.”

·         RBI sees very high liquidity currently in the banking system to the tune of Rs.5-6T; RBI will normalize liquidity gradually in a multi-year cycle rather than in FY23

·         “Let me say that the overall liquidity even today is fairly high. It's about five to six lakh crore. If you take into account the Standing Deposit Facility (SDF), the money which comes to us at the end of every day under the SDF, the amount of money under 14-day VRRR and 28-day VRRR, and the potential government expenditure, if you put all together the liquidity in the system is upwards of five lakh crore, almost going up to six lakh crore. As we have said earlier, it will be a multi-year cycle. Also, one important factor is that some of the TLTROs which we announced in the first year of the pandemic for 3 years. So, some of them will mature only in 2023 and the process will spill over into the next year also.”

·         NPA reduction process: write-off is a technical and prudential process to clean B/S of banks after providing 100%, but now there is a declining trend in write-off and an upward trend in upgradation

·         “First of all, let me clarify that these are the technical and the prudential write-off, without forgoing the right of the recovery. Second, all these loans are fully provided for, so it reflects upon prudence in the balance sheet and it reflects a better position on the balance sheet, and the third that we have seen in the last two and half years, there is a declining trend as far as write-off is concerned. There is an upward trend in the upgradation.”

·         RBI sees 6-8 months lagged effect of its rate hikes on inflation; RBI may have to wait at least Oct-Nov’22 to have an assessment about its SDF rate hike impact from Apr-May-June

·         “Usually, rate hikes take about 6 to 8 months to have their full impact. They start having their impact right from the beginning. But to have the full impact, it takes about 6 to 8 months. The impact of the rate action that we have taken starting with April, when we introduced the SDF at a higher rate – 40 basis points higher than the reverse repo – and then in May and June. We will have to wait maybe till October, or November to assess their full impact.”

·         Presently RBI has no guidance about the so-called neutral rate, but RBI may wait for inflation falls at least into the tolerance band and even aligns with the 4% target

·         “I cannot reveal the thinking of the Reserve Bank. Some Bulletin articles have appeared on neutral rates, etc., but I am not able to reveal the thinking of the RBI. Within RBI, there are multiple minds and multiple thinking and they finally converge on my table. From there, after discussion with the Senior Management, the thinking of RBI emerges. So, it will not be possible for me to reply to your question, in very explicit terms.

·         Deputy RBI Governor Patra: “The path to the neutral rate is a two-milestone journey. The first milestone is when inflation falls into the tolerance band, and the second is when it aligns with the target.”

Conclusions:

RBI sees robust domestic economic activity but elevated inflation till FY23, not only substantially above RBI’s +4.0% target but also above the upper tolerance band of +6.0%. Thus RBI has to tighten in a calibrated way to bring inflation down by curtailing demand (economic slowdown) without causing an all-out recession for a safe and soft landing. RBI (Governor Das) dialed back its earlier narrative of decoupling with the Fed after INR plunged against USD, causing more/higher imported inflation. RBI is now following Fed’s rate actions, whatever may be the narrative.

 

RBI also sees sticky domestic inflation as a function of imported inflation and global supply chain disruptions rather than elevated domestic demand and constrained supply. RBI will continue to tighten to keep USDINR under control, which will also control imported inflation.

 

Thus RBI will follow Fed’s rate action to keep the policy rate, currency, and real bond yield differential under control, everything being equal. Like most other major G10 central banks, RBI is now following Fed with a -25 bps spread; i.e. if Fed goes for a +75 bps rate hike, then RBI will hike +50 bps; if Fed goes for +50 bps rate hikes, then RBI will hike +25 bps.

Looking ahead, Fed will continue to hike for the rest of 2022 (September, November, and December), but maybe with a slower pace @ +0.50% instead +0.75% (subject to actual inflation reading)-if inflation does not surprise the upside. From September, Fed will also increase the pace of QT, which will cause further tightening in financial conditions (higher bond yields/borrowing costs). Fed also acknowledged trajectory of inflation is dependent on non-monetary conditions such as Russia-Ukraine/NATO war/geopolitical tensions and subsequent economic sanctions, causing supply chain disruptions and higher inflations.

Ahead of Nov’22 U.S. mid-term election, expect cooler inflation and hotter employment data for a ‘Golden Recession’ narrative by the White House. Fed, on its part, will jawbone the market for a +75 bps hike in September to not only control inflation expectations but also to ensure a pre-election rally in Wall Street as Fed may eventually hike by +50 bps after jawboning for +75 bps, which will be seen as a less hawkish hike.

 

Thus, assuming +50 bps rate hikes action by Fed in September, November, and December, RBI may also hike @+25 bps in September, December, and February’23 for a terminal rate of +6.15% minimum. RBI may also hike @+50 bps if Fed goes for +75 bps. RBI may also hike another +35 bps along with +25/50 bps in Feb’23, if Fed goes for minimum +25 bps rate hikes in Jan’23. RBI will ensure a positive real rate or at least zero real rates assuming core CPI is below +6% by Feb’23.

The FY22 Nifty consolidated EPS was around 762. As per the present sequential run rate, Nifty consolidated EPS may grow by around +20% in FY23 to around 914 and in that scenario, at around 20 average PE, the fair valuation of Nifty maybe around 18280; i.e. Nifty may scale around 18300-600 (lifetime high) by Mar’23 or even before by Dewali, supported by a stable macro-economic outlook, leveraged corporate balance sheet and adequate pricing power despite higher inflation, higher borrowing costs and various global headwinds. Higher USDINR may also support Nifty consolidated EPS as around 40/50% of Nifty earnings come from exports. Further sustaining above 18650 lifetime high levels, Nifty may scale 21150-22000 levels by FY24.

Looking ahead, whatever may be the narrative, technically, Nifty Future now has to sustain over 18050 for a further rally towards 18175/375 and 18600 lifetime high levels; otherwise, sustaining below 18000, Nifty Future may fall towards 17750/17630-17430/17330 and 17200/17090-16935/16800-16375/16275 and lower zones in the coming days.

 

 

 

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