Nifty may scale a new lifetime high soon on hopes of Fed/RBI pivots and upbeat earnings

Nifty may scale 21000 levels by Dec’23 (projected FY24 EPS around 1050 and average PE 20) if there is no WW-III (nuclear war) triggered by Russia

India’s benchmark stock index Nifty closed around 18145.40 Tuesday; jumped almost +6.00% for October and 1^st trading day in November on upbeat earnings report card (including guidance), and positive cues from Wall Street amid hopes & hypes of Fed pivots (smaller Fed rate hikes after Nov’22 and a possible pause by Mar’23). India’s Dalal Street was also boosted by less hawkish RBI minutes (30^th September MPC meeting).

As a recapitulation RBI hiked +0.50% on 30^th September to +5.90% against Fed’s +0.75% on 21^st September to +3.25%. India’s RBI is following its U.S. counterpart Fed. This is protecting INR from an abrupt fall and boosts FPI's confidence. INR is not a fully convertible currency. This factor along with limited CAD/BOP (deficit) after considering buoyant service export, remittances, FDIs, and negligible external loan, India has stable macro, unlike many comparable EMEs.

Angel investors are now looking for political/policy/macro/currency stability and the Indian market is enjoying a scarcity premium among EMEs due to these factors. Also, the appeal of 5D (democracy, demand, demography, deregulation, and digitalization) and the mantra of reform & perform- the Indian market is still a favorite destination for FPIs despite some selling by them in IT/Tech shares for the concern of synchronized global recession and a possible slowdown in digital tech transformation spending by big U.S./European corporates. But still, there are no such visible slowdowns in tech spending despite some concern about macro headwinds.

Dalal Street is now also looking for similar RBI pivots after less hawkish RBI minutes (for the 30^th September rate decision MPC meeting).

Statement by Dr. Shashanka Bhide (RBI MPC member)

The global macroeconomic conditions have become adverse for growth and stability, particularly for the EMEs. While there are clear signs of slowing growth momentum in the economies across the world, inflation continues at much higher rates than the target for many countries. The uncertainty due to the Russia-Ukraine war has continued to impact energy supplies and prices. While the COVID-19 pandemic has weakened, sporadic surges in some major countries are raising concern. Global monetary policy tightening to contain inflation pressures has increased the potential for significant global growth deceleration and volatility in financial markets. Declining export opportunities while imports remaining relatively high have added to the adverse external environment for the energy-importing EMEs.

The CPI inflation in India, year-on-year basis, after a run of 7 percent or more between March and June 2022, dropped to 6.7 percent in July only to rise to 7 percent again in August. With the exception of a few product groups, the high rate of price rise was widespread. Food & Beverages and fuel & light sub-groups of the CPI registered YOY rates above 7 percent throughout this period from March to August, with the exception of a rate of 6.7 percent in the case of food & beverages in July.

Only in the case of housing and pan, tobacco, and intoxicants, among the major categories of CPI, with a combined weight of 12.45 percent in the CPI, the inflation rate was below 4 percent during the period, with the exception of housing price index which rose by 4.1 percent in August. Among the other remaining sub-categories, clothing and footwear registered an inflation rate of about 9 percent, and the other remaining consumption items constituting the ‘miscellaneous’ sub-category registered an inflation rate of above 7 percent in March and April followed by lower rates of 5-7 percent in the subsequent May-August period. However, there was a decline in the month-over-month momentum of the overall CPI in May 2022 and it remained steady from June-August.

The policy response across the world has been to tighten monetary policy. This policy stance is expected to continue to achieve inflation targets.

The persistence of the higher rate of a price increase at commodity and sectoral levels in the domestic market is on account of both the direct or spill-over effects of higher international market prices and also domestic factors. Any decline in prices at the consumer level appears to be restrained by elevated levels of input prices although RBI’s enterprise surveys indicate that the input price pressure is expected to ease in the second half of the current financial year.

The RBI survey of households conducted in September 2022 on price expectations indicates expectations of the continued high rate of inflation, with the average expected inflation rate being higher than in the survey conducted in July 2022. The inflation rate is also expected to be higher 3-months ahead and one year ahead compared to the prevailing situation. The expectations of future price readings appear to be affected more by the present conditions than the likely impact of the decline in commodity prices in the international markets.

The survey of enterprises (Industrial Outlook Survey) conducted by RBI in September 2022 reflects some relief on selling prices in H2:FY2022-23 as the proportion of respondents who expect selling prices to rise drops compared to Q2: FY 2022-23. Although financing costs are expected to increase, other input cost pressures are expected to decline. The Wholesale Price Index, reflecting the price conditions at the producer level, has registered a double-digit rate of increase YOY basis in July and August.

While there is a variation in the price changes across the broad range of commodities, in a few major categories of commodities, the price rise is significant. In the case of vegetables, fruits, crude petroleum, petrol, diesel, LPG, and electricity, the WPI increased at double-digit rates in July and August. In the case of cereals, the increase was 9.8 percent in July and 11.8 percent in August. The impact of the decline in international market prices on domestic prices is yet to pass through to domestic consumer prices.

The rainfall in the monsoon period of June-September has exceeded the Long Period Average by the last week of September although the rainfall has been deficient in parts of the eastern and north-eastern regions for much of the monsoon period. The monsoon rains in the aggregate have improved the Rabi crop prospects. Food commodity prices in the consumption basket will be subject to the size of the Kharif harvest in the short run.

In the context of the continued high inflation rate, the monetary policy rate has increased between May and August 2022. While the impact of this increase is beginning to affect the lending and deposit rates of the banking sector, its main impact on inflation would be through expectations of a decline in the future inflation rate and on the aggregate demand. There are of course other factors such as the slowing down of the global economy and its impact on exports and aggregate demand. At this juncture, the adverse impact on aggregate demand may be insulated by seasonal factors such as the festival season demand and the Kharif crop harvest.

The Q1: FY2022-23 estimates of national income by the NSO place constant price GDP growth at 13.5 percent over the same period in the previous year. This is lower than the RBI’s projection of 16.2 percent provided in the August meeting of the MPC. Despite the lower than the projected growth, it reflects sustained improvement in growth over the pre-pandemic output level of 2019-20 that began in Q2:FY2021-22. Both Private Final Consumption Expenditure and Gross Fixed Capital Formation, two major components of aggregate demand, registered a sharp increase in Q1:FY2022-23 YOY basis. In this sense, the overall growth momentum appears to have been sustained in Q1.

Given the lower estimates of GDP growth for Q1, there is uncertainty over sustaining the growth momentum needed to achieve growth of 7.2 percent for the full year, as projected in the August MPC meeting. There are also signs of weakness in demand conditions in the qualitative results of the RBI surveys of Enterprises (Industrial Outlook). The overall Consumer Confidence Index as per the Consumer Confidence Survey (urban households) shows optimism for one-year ahead expectations, albeit, prevailing conditions are seen to be pessimistic.

The increase in consumption expenditure over the previous year and one-year ahead expectation is more widely shared with respect to ‘essential expenditure’ as compared to ‘non-essential expenditure’. The expectations of overall business outlook over the remaining quarters of FY 2022-23, based on the Enterprise Surveys for September 2022 reflect optimism but also divergence in sentiments in manufacturing, services, and infrastructure sectors. In this context, the revised GDP growth projection for FY 2022-23 is now at 7.0 percent compared to 7.2 percent in August. The quarterly growth rates for the year are provided in the Resolution.

In sum, there are significant uncertainties over the trajectories of growth and inflation. On the growth front, the COVID-19 pandemic-related supply-side constraints do not appear to be significant. Improvement in private investment and consumption spending would require price stability. The CPI inflation rate has continued to be high – above/more than 6 percent, from January 2022 onwards. While there are indications of a decline in the momentum of price rises, sustaining this decline in momentum is crucial for achieving inflation and growth objectives. To align the inflation expectations with the policy target rate of inflation, a further increase in policy rates is necessary at this juncture.

I vote to increase the policy repo rate by 50 basis points to 5.9 percent. I also vote to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.

Overall, Bhide sounded quite hawkish.

Statement by Dr. Ashima Goyal (RBI MPC Member)

To start with global factors, major advanced economy central banks over-stimulated after Covid-19 and are overreacting to inflation now, creating excess volatility in cross-border flows to emerging markets (EMs). Forward guidance, whether hawkish or dovish, is harmful in such uncertain times. Being data-based allows real-sector changes to counter the effect of interest rates on markets.

There are two mitigating factors for India, however. First, after an initial extreme reaction, cross-border flows discriminate on a country basis. As commodity prices soften with a global slowdown, some of the investors who had left India because of its vulnerability to commodity inflation will return. Second, India still retains policy space for smoothing global shocks. Domestic demand can counter falling export demand. It is important for policymakers to stay calm to moderate fear and overreaction.

Turning to the domestic situation, global commodity price softening affects WPI more initially. CPI is rising because of cereal and ends monsoon food price spike. As a result household inflation expectations rose, while those of firms fluctuated around 5% according to the IIM Ahmedabad survey. Rising uncertainty shows in the increasing dispersion of household inflation expectations. But firms still see inflation at 5.5% by mid-2023.

While India has one of the highest year-on-year growth rates in the world there are some signs of slowing down. Quarter-on-quarter GDP contracted in Q1. The OECD points out that seasonally adjusted Indian quarter-on-quarter growth was the lowest after China and Poland. It is uncertain if domestic demand will sustain after the festival spike. RBI consumer surveys show that 45% of households reported no increase in income levels compared to a year ago.

Although the large pandemic-time repo rate cut is reversed, we are not yet at the terminal rate. Demand reduction has to contribute, along with other measures, to lowering the current account deficit. A firm monetary policy reaction to inflation exceeding tolerance bands helps anchor expectations. The repo rate has to rise more. But should the rise be taken upfront or staggered over time? We examine the arguments for and against frontloading.

When behavior is forward-looking front loading can pre-empt inflationary pressures. But if lagged effects of monetary policy are large, as in India, overreaction can be very costly. Harmful effects become clear too late and are difficult to reverse. Gradual data-based action reduces the probability of over-reaction. Taking Indian repo rates too high imposed heavy costs in 2011, 2014, and 2018. A credit and investment slowdown was aggravated and sustained. It is necessary to go very carefully now that forward-looking real interest rates are positive.

The sacrifice of output from tightening is low if unemployment is low and there is excess demand. Setting rates to reduce excess demand to zero has little output cost and the need for future rate hikes is reduced. In India, however, unemployment is high. That there is no second-round inflation from wage rise points to slack labour markets. Employment is just recovering from a series of global shocks and demand may be slowing.

High uncertainty also calls for slow steps. If demand slows anyway, less policy tightening will be required. That both inflation and growth were slightly lower than last quarter's RBI projections may indicate the effect of tightening was underestimated. It is necessary to monitor the softening of commodity prices. If they slump real rates can shoot up too high as in 2014-15.

If inflation expectations are unanchored a large sacrifice may be called for to reverse them. But in EMs communication has more impact. Continuing supply-side action, global softening, and transparent communication about these factors all help anchor inflation expectations. If the target is headline inflation with a large commodity component for which fiscal action has a greater impact there is more responsibility on the government to act. The Indian government has demonstrated a commitment to lowering the costs of living and to improving infrastructure.

A BIS study of past country experience including 6 EMs found frontloaded actions tend to be followed by soft landings but an average of 45% of the policy rate rise was frontloaded in soft landings and the mean nominal rate hike was 2%. Large hikes were required in India to reverse steep pandemic-time cuts. Since that is completed, going slow now will allow the policy to be agile and data-based. Extremes are always dangerous; 100% front loading can easily overshoot. Moderation is better.

Households tend to have a stagflationary view, so they expect inflation to rise when growth falls. In addition, Indian households expect inflation to increase if the repo rate increases. Excessive rate rises will not make inflation targeting credible if they are unable to lower supply-side inflation and instead raise costs as demand and investment fall.

Most analysts are arguing for a 50 bps rise just to preserve a spread with US policy rates. This is a fear-driven overreaction. In the mid-2000s the spread was less than 150 bps and there were large capital inflows. In the past 2 years, spreads of above 300 bps have not brought in debt flows. If the terminal Fed rate is 5%, will it require we raise ours to 8%? The carry trade is not a stable source of financing. India has earned enough independence to protect itself from the policy errors of other nations.

In view of all these considerations, and to signal tapering of action, I vote for a 35 bps rise in the repo rate. Both RBI and SPF headline forecasts for Q1 FY2023-24 are around 5%, implying the real rate will be approximately 0.75% with the repo rate at 5.75%. This is almost one and can exceed unity if the fall in inflation is larger. This could be dangerous if growth slows. The MPC has to focus on the 6 months to one year ahead real rate, as this is the horizon where monetary policy will have its greatest impact.

Moreover, as banking liquidity is tightening, there will be more passing through. Over time LAF tools and forecasting of liquidity shocks should develop to the point where a neutral MPC stance implies weighted average money market rates are maintained in the middle of the LAF corridor. At present, I vote to continue with the ‘withdrawal of accommodation stance’ since durable liquidity is still in surplus. This, together with the adequate adjustment of short-term liquidity, is required to counter global quantitative tightening (QT) and possible outflows, as required. The very slow pace of QT compared to the large surplus created, along with selective CB interventions, may be sufficient, if we are lucky, to prevent financial instability despite the rapid coordinated global rise in policy rates.

Overall, Goyal, a known policy dove sounded quite dovish as expected. As per Goyal, the Indian real rate would be positive by Q1FY24, when headline inflation is expected to fall around +5.00% and thus she wants smaller hikes and subsequent pauses; i.e. RBI pivots rather than continuous hiking in line with Fed for the sake of keeping interest rate differential spread.

Statement by Prof. Jayanth R. Varma (RBI MPC Member)

I wrote in my August statement that further withdrawal of accommodation is warranted beyond the rate increase in that meeting. However, I also indicated that we may be beginning to approach the terminal repo rate. My view remains largely the same today and based on this, I think the MPC should now raise the policy rate to 6 percent and then take a pause.

A pause is needed after this hike because monetary policy acts with lags. It may take 3-4 quarters for the policy rate to be transmitted to the real economy, and the peak effect may take as long as 5-6 quarters. If we raise the repo rate to around 6 percent at this meeting, that would be a cumulative increase of around two percentage points in the space of just four months. Even this understates the extent of monetary tightening, because, a few months ago, money market rates were close to the reverse repo rate (65 basis points below the repo rate). Taking this into account, the full magnitude of monetary tightening would be well over 250 basis points.

Much of the impact of this large monetary policy action is yet to be felt in the real economy. In fact, much of the policy rate action is yet to be transmitted to even the broader spectrum of interest rates. For example, less than a third of the increase in the repo rate during April-August has been transmitted to retail bank deposit rates. Bank deposit interest rates play a critical role in stimulating savings, dampening consumption demand, and thereby mitigating inflationary pressures. We should hopefully see more of this transmission in the ensuing quarters. While there has been a much higher transmission from policy rates to lending rates, the transmission from lending rates to the real economy would also take time.

All this means that it is too early to know whether the policy action so far is sufficient or not. It may well turn out that even more monetary tightening is required, but it does make sense to wait and watch to see whether a repo rate of around 6 percent is sufficient to glide inflation back to target. If we were to continue to tighten without a reality check, we would run the risk of overshooting the repo rate needed to achieve price stability.

It is true that inflation is currently well above 6 percent. However, since monetary policy acts with lags, what is relevant is the inflation forecasts 3-4 quarters ahead. Both the RBI’s forecasts and the survey of professional forecasters show inflation falling to around 5 percent in the first quarter of the next financial year. Relative to this forecast, a policy rate of around 6 percent would not only be a positive real rate but also likely above the neutral rate.

In my view, it is dangerous to push the policy rate well above the neutral rate in an environment where the growth outlook is very fragile. While the level of economic output has recovered to pre-pandemic levels, it remains well below the pre-pandemic trend line. Tightening global financial conditions and recessionary fears in advanced economies are acting as drags on the domestic economy as well. Weakening export growth means that economic growth has to be driven by domestic demand which is still not sufficiently robust.

Much of the hope for economic growth rests on the possibility of a revival of private investment in response to rising capacity utilization. We should be careful to ensure that an unreasonably high real interest rate does not thwart this much-needed upswing of the investment cycle. Compared to the previous meeting, the upside risks to inflation have abated with moderation in crude oil prices and continued weakness in other commodity prices.

I have given careful consideration to the extensive analyst commentary suggesting that a terminal repo rate of 6.25 or 6.50 percent is appropriate. Much of this analysis is from the perspective of the balance of payments. It is true that in the past (notably in 1998 and 2013), India has very successfully used interest rates to defend the currency. However, all these episodes were before the inception of an inflation-targeting MPC in 2016.

The statutory mandate restricts the MPC from considering only two factors while setting interest rates - inflation and growth. It was a conscious legislative choice to let monetary policy be dictated by domestic economic considerations, and leave the external sector to be managed using other instruments. This means that the MPC cannot be guided by the effect of global monetary tightening on the interest rate differential.

My votes on the MPC resolutions are informed by these considerations. For the first resolution on the quantum of the rate hike, I considered three alternative choices: 35, 50, and 60 basis points corresponding to repo rates of 5.75, 5.90, and 6.00 percent. I think that 5.75 percent would be well below the terminal repo rate, would leave the task of monetary tightening unfinished, and make it necessary to hike rates again in the next meeting. My preference is clearly for a front-loaded hike to the 6 percent level that I have argued for in the above paragraphs.

The majority of the MPC has chosen 5.90 percent which is only slightly below my preferred rate of 6 percent. As I have explained in past statements, 10 basis points are not material and I am happy to go along with the majority of the MPC on this issue. Therefore, I vote in favor of increasing the policy repo rate by 50 basis points to 5.90 percent. However, I vote against the second resolution because in my view the MPC should now pause rather than focus on further tightening.

Overall, Varma, a known hawk in the past is now talking less hawkish than expected and as par his perception, a repo rate of around +6.00% (~5.90%) should be set as the terminal rate considering RBI’s expectations that headline CPI may fall to +5.00% on an average by Q1FY24. Thus RBI should take a pause after September’s +50 bps hike.

Statement by Dr. Rajiv Ranjan (RBI-MPC Member)

Central banks across the globe continue their fight against inflation this year with more than a dozen central banks hiking rates by 75 bps or even more in one go. While global financial markets are witnessing the immediate brunt with associated spillovers for emerging markets including India on account of risk-off sentiment and US dollar strength, a ‘historic’ global growth slowdown is the medium-term risk that the world economy has to face.

India is in a much better position relative to many other parts of the world. Growth is resilient, and that is also encapsulated in an upgrade in growth forecasts for Q2, Q3, and Q4 of 2022-23. Although exports are vulnerable to global growth slowdown, it could be offset by some favorable spillovers from lower global commodity prices coupled with other factors alluded to in the following paragraphs.

For Q1:2022-23, the National Statistical Office (NSO) estimate of real GDP growth at 13.5 percent was lower than our projection of 16.2 percent. Despite a strong pick up in private consumption and investment which supported aggregate demand in Q1, lower growth in government consumption and a higher drag from net exports contained growth in real GDP. High growth in real imports - with lower-than-expected deflator inflation at 13.7 percent despite the sharp rise in import prices - outpaced real export growth significantly.

Again, growth in contact-intensive services as reflected by GVA growth in trade, hotels, transport, communication, and services related to broadcasting also fell short of expectations. While this sector had exceeded its pre-pandemic level by 1.7 percent in Q4:2021-22 in a quarter marred by Omicron, it slipped below its pre-pandemic level by 15.5 percent in Q1:2022-23 which was a relatively normal quarter. Assuming this sector could have just reached its pre-pandemic level in Q1:2022-23 (i.e., at the Q1:2019-20 levels), real GVA growth would have been 16.1 percent during the quarter. Notably, this sub-group accounted for about one-fifth of the GVA in the pre-pandemic period.

Accordingly, the projection for H2:2022-23 has been revised upwards. It is also expected that the economic activity is likely to sustain momentum with the full-fledged celebration of festivals after two years on the back of buffers of excess household savings, which will aid private consumption. Even though household’s financial savings have normalized from a peak level of 12.0 percent of GDP during 2020-21 to 8.3 percent in 2021-22, it is estimated that households still had an excess saving of around 7 percent of GDP in end-March 2022 - based on their net worth which is higher than the level at end-March 2020.

As consumption gathers traction and capacity utilization surges beyond a threshold, this could fuel investment – the second engine of growth. The real GDP growth for 2023-24, based on our macroeconomic model, is projected at 6.5 per cent. India assumed the G-20 presidency in 2023 and is likely to support economic activity with large infrastructure and tourism-related investments.

Since the last bi-monthly, headline CPI inflation after moderating to 6.7 percent in July edged up to 7.0 percent in August. Even so, month-over-month change in headline CPI (or price momentum) was steady at around 0.5 percent during June-August 2022 and two-way movement in inflation was brought about by base effects. Food and CPI core (CPI excluding food and fuel) drove price momentum in recent months, with core inflation remaining sticky around the upper tolerance threshold of 6 percent.

Food inflation registered a significant pick-up in August on the accentuation of price pressures in cereals along with pulses, milk, vegetables, and spices. Various exclusion-based measures of core were in the range of 5.9 percent to 6.2 percent in August. In fact, all trimmed mean measures of core inflation edged up in August and were in the range of 6.2 percent to 6.8 percent, with the weighted median registering a sharp 80 bps pick-up in August to 6.5 percent. In some ways, a pick-up of price pressures in the core in August is also visible from core diffusion indices which firmed up in August. Inflation expectations also remain elevated.

There is, however, a reason for confidence in inflation slowing down within the tolerance band next fiscal, given lagged impact of RBI rate hikes and easing of supply constraints. RBI’s quarterly model-based projection shows that the inflation rate during 2023-24, on average, will be 5.2 percent.

In the current macroeconomic mix, while a rate hike in this meeting is imminent, the choice between 35 to 50 bps is a close call. Given the growth-inflation dynamics, my vote is for an increase in the repo rate by 50 bps and continuing with the policy stance of withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.

First, with the current inflation level and the uncertainty around it, mooring of inflation expectations is important to restrain the broadening of price pressures and enhance the credibility of the central bank, the benefits of which I had explained in my last minutes.

Second, by showing continued commitment to the inflation target, the monetary policy seeks focused attention on its ‘inflation mandate’. As we are living in an information-rich world, we may get carried away by certain information-fraction and tend to form expectations, impacting prices, consumption, and investment. The committed monetary policy actions fix the attention of various agents in the economy on the ‘inflation mandate’ even when the current inflation is elevated. This, in turn, will again help to anchor inflation expectations.

Third, the resilient growth about which I mentioned before provides us the space to act.

Fourth, despite the recent empirical evidence supporting the perceived wisdom that real neutral rates declined both globally as well as in India, we need to keep in mind the level of inflation and surplus liquidity conditions prevailing at this juncture.

Reflecting the increases in the policy repo rate, the weighted average lending rate (WALR) on fresh rupee loans of SCBs has increased by 82 basis points during the period of May to August 2022. The increase in the share of external benchmark lending rate (EBLR) linked loans (46.9 percent as of end-June 2022) coupled with a shorter reset period for such loans have significantly improved the pace of transmission to WALR on outstanding loans. On the liability side, pass-through to term deposit rates are higher, if one considers both retail as well as bulk deposits. The extent of transmission is expected to improve further with the upward revision in interest rates on some small savings instruments.

In a scenario where growth momentum gains further traction and inflation pressures are projected to remain elevated over the remaining part of the year, before registering a moderation by Q1:2023-24, monetary policy has to persevere with its exit from accommodation to ensure that calibrated policy rate hikes dampen inflation expectations and firmly establish our commitment to price stability. This would help achieve the optimal mix of growth and inflation which will set the foundations for a high growth trajectory over the medium term.

Overall, Ranjan sounded quite hawkish as he sees elevated inflation, but robust economic growth and thus favored a slightly higher terminal rate than around +6.00%.

Statement by Dr. Michael Debabrata Patra (Dy. RBI Governor and MPC Member)

Central banks race in lockstep to raise policy rates by much more than their own historical experience. After all, current levels of inflation haven’t been seen in decades. Are they overshooting, or overdoing it?

They are balancing the prospects of a recession against the risks of inflation remaining elevated and persistent. Given their mandates and the credibility they work hard to earn (in the pandemic, they prioritized revival over price stability which cannot be faulted, but it is), they prefer now to err on the side of hawkishness in their determination to bring inflation to targets, fearing a 1970s redux.

This inflation shock defeats conventional forecasting models. The parameters that characterize recent developments are far outside the ranges predicted by conventional models. No one knows what is too far or what is far enough in this environment. Central banks, therefore, adopt a risk minimization strategy, ensuring they eradicate inflation while allowing them to correct course and lower interest rates later if necessary.

Even so, currently available projections of inflation suggest that the real policy rates will remain negative up to the close of 2022. Hence, a more forceful tightening of monetary policy in 2023 may be required if terminal rates have to be achieved. This is being reflected in aggressive forward guidance, which has effectively restrained the relief rally that followed in the wake of the pricing of large rate actions in the recent past. Currency slides have become cliff events. Equities and bonds alike are selling off. Extreme risk aversion grips markets and investors.

Inflation management is suddenly complicated by the crystallization of the impossible trinity. The conduct of domestically oriented monetary policy is becoming hostage to unidirectional exchange market volatility and mobile capital flows seeking haven. Recession risks may be darkening the horizon, but more immediately, global macroeconomic and financial stability is under threat. No country is immune. Systemic central banks should pay heed to the possibility that today’s spillovers can become tomorrow’s spillbacks.

For net commodity importers like India, with over a third of the CPI being imported, negative terms of trade shock convolute macroeconomic management. As current account deficits widen and capital flows turn fickle, reserve depletions become not just sources of forex liquidity to a risk-wrung market but also instruments of stabilizing expectations – the RBI stands for stability. Minimizing volatility in the exchange rate becomes important from two points of view: (a) limiting risks to financial stability from foreign exchange exposures and pressures on margins of corporations, and (b) ensuring orderly functioning of financial markets so that volatility does not translate into financial stability risks. Accumulations during happier times have proved to be prudent.

Spillovers are global and overwhelming; however, the responsibility for securing stability is national. Each country is on its own.

In India, the moderation in inflation that had commenced in May 2022 has been interrupted by supply shocks which may extend into September. Although these shocks appear transitory at this juncture – barring energy prices which will be shaped by the evolving geopolitical situation – it is critical to remain watchful about second-order effects if the shocks persist or recur. What is disquieting, however, is that inflation stripped of these transitory effects has become unyielding and tightly range-bound around the upper tolerance band of the inflation target.

The RBI’s forward-looking surveys suggest that selling prices in manufacturing and services may rise further as pass-through from input cost pressures remains incomplete. Exchange rate volatility is amplifying these core price pressures, especially in view of key import prices being invoiced in the US dollar. Inflation expectations are rising, with signs that they are becoming unanchored over one year ahead horizon. Taken together with a closing output gap, rising capacity utilization in manufacturing, surging demand for services, and the pick-up in spending as the festival season nears, monetary policy must move to red alert.

At this critical juncture, monetary policy has to perform the role of nominal anchor for the economy as it charts a new growth trajectory. The focus should be on being time consistent in aligning inflation with the target. In this context, front-loading of monetary policy actions can keep inflation expectations firmly anchored and balance demand against supply so that core inflation pressures ease. It will also reduce the medium-term growth sacrifice associated with steering inflation back to target because it is being timed into the strengthening of the recovery of the domestic economy that is underway and likely to gather further momentum as the year progresses.

Accordingly, I vote for increasing the policy repo rate by 50 basis points and for maintaining the stance of withdrawal of accommodation.

Overall, RBI Dy. Governor Patra sounded more hawkish than usual as he sees elevated inflation in the coming days and the need for bringing core inflation down to around +4% targets by restraining demand in line with constrained supply.

Statement by Shri Shaktikanta Das (RBI Governor and MPC Member)

The world is in the eye of a new storm originating from aggressive monetary policy tightening and even more aggressive forward guidance from advanced economy (AE) central banks. This has resulted in a tightening of global financial conditions, extreme volatility in financial markets, risk aversion among investors, and a sharp appreciation of the US dollar. Such market turmoil on top of globalization of inflation and de-globalization of trade has hugely negative consequences for emerging market economies (EMEs). Even in AEs, the narrative is increasingly shifting from stagflation to a possible recession. These developments are taking place even as the world is still grappling with the shocks from COVID-19 and the conflict in Ukraine.

Amidst all these, the Indian economy presents a picture of resilience with macroeconomic and financial stability. The balance sheet of key stakeholders like corporates and banks remains strong. In an interconnected world, however, the Indian economy is impacted by the unsettled global environment. There are pronounced consequences not only for our domestic inflation and growth dynamics but also for financial markets.

Headline inflation, on the other hand, remains elevated and above the upper tolerance band of the target. As per current projections, headline CPI is expected to moderate to 5.8 percent in Q4 of 2022-23 and further to 5.0 percent in Q1 of 2023-24. The future trajectory remains clouded with uncertainties arising from continuing geopolitical conflicts, the possibility of further supply disruptions, volatile financial market conditions, and domestic weather-related factors.

Overall, I remain optimistic about the prospects of the Indian economy, its resilience, and its capacity to deal with current and emerging challenges. We need to do whatever is necessary and under our control to restrain the broadening of price pressures, anchor inflation expectations, and contain second-round effects. The need of the hour is calibrated monetary policy action, with a clear understanding that it is required for sustaining our medium-term growth prospects. Accordingly, I vote for raising the policy repo rate by 50 bps.

As regards the stance, I vote for remaining focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. It is important to note that even though the policy rate has moved to pre-pandemic levels, the overall monetary conditions taking into account the liquidity position and the inflation remain accommodative. The net liquidity adjustment facility (LAF) continues to be in surplus for more than three years. Liquidity in the system may also be seen in totality taking into account all moving variables including excess CRR and SLR holdings of banks, and revenue and expenditure patterns of the government.

Going forward, monetary policy needs to remain watchful and nimble, based on incoming data and evolving conditions. We should remain vigilant on the inflation front while strengthening our macroeconomic fundamentals. The financial and external sectors also continue to be under the Reserve Bank’s close watch. In the final analysis, there is optimism and confidence around the India growth story and our current activity is expected to add credence to that narrative.

Overall, RBI Governor Das sounded quite hawkish in the sense that going forward he wants calibrated tightening as per incoming data (inflation) and evolving outlook. Das also noted that despite the policy/repo rate having moved to pre-COVID levels, the policy is still accommodative and thus there is a need for removing accommodation going forward in a calibrated manner to bring down inflation closer to the target keeping in mind overall economic growth; i.e. to ensure price stability ensuring safe and soft landing or even a blockbuster take-off! (Without causing an all-out economic slowdown/recession or bringing down inflation even with economic growths above/inline trend).

Conclusions:

RBI sees resilient domestic economic activity but elevated inflation till at least Q4FY23. RBI projected +5.8% CPI and +4.0% real GDP growth. And further +5.0% headline CPI and +7.2% real GDP growths for Q1FY24. Thus two RBI MPC members (external) Goyal and Varma stressed the terminal rate of around +6.0% which would be a real positive rate considering if inflation dips to around +5.0% by Q1FY24. Thus out of six MPC members, two batted for RBI terminal rate around +6.00%, while the rests are for some more hikes in September. Overall, September RBI minutes were less hawkish than expected with signs of RBI pivots, and thus both Nifty and USDINR got some boost. But both RBI Governors and Dy. Governors are for a higher terminal rate.

India’s headline inflation (CPI) jumped +7.41% in September (y/y) and +0.57% sequentially (m/m), while core inflation also surged +6.07% in September from +5.84% reading in August. The average CPI is now around +6.89% (y/y), sequential reading +0.60%; i.e. annualized +7.14%, while average core inflation is around +6.11% (y/y)-all are substantially above RBI target +4.00% and also above RBI’s upper tolerance levels of +6.00%. India’s inflation expectation (1Y) is also quite elevated, usually running around +400 bps above actual average inflation data, and was +11.00% in September as per an RBI survey.

RBI also sees sticky domestic inflation as a function of imported higher inflation and global supply chain disruptions rather than elevated domestic demand and constrained domestic supply. RBI virtually blamed global supply chain disruptions and elevated fuel & food prices for sticky domestic inflation as a result of Russia-Ukraine geopolitical tensions and subsequent economic sanctions (on Russia). Thus RBI will continue to tighten to keep interest rate/bond yield differential and also USDINR under control, which will also control imported inflation and manage overall price stability. RBI has to tighten in a calibrated way to bring inflation down by curtailing demand; i.e. slowing down the economy to some extent without causing an all-out recession for a safe and soft landing.

In September RBI MPC minutes, two external members argued for a terminal rate of around +6.00% based on RBI’s September projection of headline CPI at around +5.00% by Q1FY24; i.e. they want a real positive rate of around +1.00%. In his monetary policy statement on 30^th September, RBI Governor Das pointed out pre-COVID era (June 19) real repo rate was around +2.00 to 2.50% as the repo rate was +5.75% against headline CPI around +3.00%, core CPI around +4.00% and 6M inflation expectations was around +3.4 to +3.7% (for H2FY20). Previously, Das also indicated that RBI will go by 6M inflation expectations, actual average CPI, and also core inflation.

And if we see previous records of RBI projection for inflation, it’s terrible and actual data is nowhere near the RBI estimates. Thus RBI can’t decide terminal rates simply based on its projections 6-months down the line. India’s core CPI is consistently hovering around +6.00% for the last few years even before COVID and Russia-Ukraine war led to global supply chain disruptions. India has its domestic supply chain issues and also higher demand, mainly due to the rampant flow of corrupt money in the economy generated from various government projects/capex/grants and also fraudulent bank lending. Thus RBI has to tighten the policy and keep the repo rate around +7.50% by June’23, so that the real rate would be around +1.50 to +2.00% wrt at least core inflation (+6.00% on average).

As per Taylor’s rule, for India:

Recommended policy rate (I) = A+B+(C+D)*(E-B) =0.50+4+ (1.5+0)*(6-4) =0+4+1.5*2=0.50+4+3=7.50%

Here for RBI/India:

A=desired real interest rate=0.50; B= inflation target =4; C= permissible factor from deviation of inflation target=1.5 (6/4); D= permissible factor from deviation of output target from potential=0; E= average core CPI=6

As per Taylor’s rule, for the US:

Recommended policy rate (I) = A+B+(C+D)*(E-B) =0.00+2.00+ (0+0)*(5.5-2.00) =0+2+3.5=5.5%

Here for U.S. /Fed

A=desired real interest rate=0.00; B= inflation target =2.00; C= permissible factor from deviation of inflation target=0; D= permissible factor from deviation of output target from potential=0.00; E= average core CPI=5.5

The market is now expecting that Fed will hike +75 bps on 2^nd November and +50 bps on 14^th December for a terminal rate of +4.50% by Dec’22. Then Fed may further hike +25/50 bps cumulative in Feb’23 and Mar’23 or even +100 bps (if core inflation does not cool sufficiently) for a terminal rate of +4.75% or +5.00% or +5.50% by Q1CY23 and pause for Q2CY23 (Fed pivots).

Looking ahead, India’s inflation may surge more amid elevated demand in Festival Season: Q3FY23 (October-November-December’22)-it will also support economic growth at the same time. Thus jumbo Fed hiking, elevated domestic inflation, and robust economic growth may force RBI to continue to follow the Fed hiking path and RBI may hike +0.50% on 7^th December (against Fed’s probable +0.75% on 2^nd November); +0.35% on 8^th February (against Fed’s probable +0.50% on 14^th December and +0.25% in Jan’23) to reach at least +6.75% terminal rate by Feb’23 (against Fed’s +4.75%).

In 2023, depending upon the actual inflation trajectory for Q4CY22 (October, November, and December), Fed may further hike at least 25/50-100 bps in Q1CY23 for a terminal rate of +4.75% or +5.00% or +5.50%. RBI may like to maintain at least +200 bps spread against pre-COVID era +400 bps. Thus RBI may go for a terminal rate of +6.75% (against the Fed’s +4.75%) or +7.00% (against the Fed’s +5.00%) or +7.50% (against Fed’s +5.50%) by June’23 in a calibrated manner.

India at present pays around 45% of its core revenue as interest on public debt, which is quite high compared to the US ratio of around 9%, the EU around +4.5%, and Japan around 15%. Although most of the Indian public debt is the domestic and local currency, India needs to balance inflation, borrowing costs (bond yields), and capex/grants in a calibrated/sustainable manner. There are huge opportunities in improving the country’s infra, especially in railways. India now needs targeted fiscal stimulus and population control policy to improve productivity and per capita GDP/income.

At around 846 TTM EPS (consolidated), the current PE of Nifty (18112) is around 21.4. The FY22 (31^st March 22) consolidated Nifty EPS was around 762; considering an average CAGR of +20%, the FY23 Nifty consolidated EPS should be around 915, and assuming a fair/median PE of 20, the fair value of Nifty should be around 18300.

Now looking ahead to FY24, Nifty EPS may grow around 15% considering higher borrowing costs, economic slowdown, but deleveraged corporate and India’s appeal of 5D. Thus FY24 Nifty consolidated EPS should come to around 1050 and assuming an average PE of 20, Nifty may scale 21000 levels by Dec’23. Also higher USDINR because of the stronger US dollar index and ultra-hawkish Fed policy (despite Fed pivot) may help as almost 60% of Nifty earnings come from exports. Fed may keep the 5.00% or even 5.50% terminal rate at least till Dec’23 unless core PCE inflation stabilizes around +2.00% targets. But Fed may also go for rate cuts and even launch QE-5 in early 2024 to boost US economy/Wall Street ahead of Nov’24 U.S. Presidential election.

Bottom line:

Dow Future may further rally in the coming days on hopes & hypes of Fed pivots and a possible loss by Biden in the U.S. midterm election, which would prevent any tax hike legislation (corporate and super-rich) by the White House. Also, an upbeat earnings report should help. India’s Nifty Future should also follow the Dow Future movement and scale 18600 or even new highs by Dec’22. Further Nifty may scale 21000 levels by Dec’23.

Looking ahead, whatever may be the narrative, technically Nifty Future now has to sustain over 18150 for a further rally towards 18250/18375-18600 (lifetime high); otherwise sustaining below 18100-18000, Nifty Future may again fall to 17800/600-500/400 and lower levels in the coming days.

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